UNITEDTable STATESof Contents

~~SECURITIES~~UNITED ~~AND~~STATES ~~EXCHANGE COMMISSION~~

~~WASHINGTON,~~SECURITIES DCAND ~~20549~~EXCHANGE COMMISSION

~~FORM~~WASHINGTON, ~~10-Q~~DC 20549

~~(Mark~~FORM ~~One)~~10-Q

~~x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15~~(dMark One) ~~OF THE SECURITIES EXCHANGE ACT OF 1934~~

~~For~~x ~~the~~QUARTERLY ~~quarterly~~REPORT ~~period~~PURSUANT ~~ended~~TO ~~March 31,~~SECTION ~~2007~~13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

ORFor the quarterly period ended March 31, 2009

~~¨ TRANSITIONAL REPORT PURSUANT TO SECTION 13~~ OR ~~15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.~~

~~For~~¨ ~~the~~TRANSITIONAL ~~Transition~~REPORT ~~Period~~PURSUANT ~~from to~~ TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

~~Commission~~For ~~File~~the ~~Number:~~Transition ~~0-24626~~Period from to

~~COOPERATIVE~~Commission ~~BANKSHARES,~~File ~~INC.~~ Number: 0-24626

~~(Exact~~COOPERATIVE ~~Name~~BANKSHARES, ofINC. ~~Registrant as Specified in Its Charter)~~

North Carolina		56-1886527
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
201 Market Street, Wilmington, North Carolina		28401
(Address of Principal Executive Offices)		(Zip Code)

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (910) 343-0181

North Carolina

56-1886527

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨


201 Market Street, Wilmington, North Carolina		28401
(Address of Principal Executive Offices)		(Zip Code)

~~Indicate~~Registrant’s bytelephone ~~check mark whether the registrant is a large accelerated filer~~number, ~~an accelerated~~including ~~filer~~area orcode: ~~a non~~(910) 343-~~accelerated~~0181 ~~filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.~~

~~Large~~Indicate ~~accelerated~~by ~~filer ¨ Accelerated~~check ~~filer~~mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x ~~Non-accelerated filer~~NO ¨

Indicate by check mark whether the registrant ishas asubmitted ~~shell~~electronically ~~company~~and ~~(as~~posted ~~defined~~on inits corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule ~~12b~~405 of Regulation S-2T (§ 232.405 of this chapter) during the ~~Exchange~~preceding ~~Act~~12 months (or for such shorter period that the registrant was required to submit and post such files). YES ¨ NO x¨

AsIndicate ofby ~~April 30~~check mark whether the registrant is a large accelerated filer, ~~2007~~an accelerated filer, ~~there~~a ~~were~~non-accelerated 6filer or a smaller reporting company. See definition of “accelerated filer,~~520,391~~” ~~issued~~“large accelerated filer” and ~~outstanding~~“smaller ~~shares~~reporting company” in Rule 12b-2 of the ~~registrant’s~~Exchange ~~Common Stock~~Act. (Check one):

~~INDEX~~Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company x

PART I	Financial Information	3
Item 1	Financial Statements	3
	Consolidated Statements of Financial Condition, March 31, 2007 and December 31, 2006	3
	Consolidated Statements of Operations, for the three months ended March 31, 2007 and 2006	4
	Consolidated Statement of Stockholders’ Equity, for the three months ended March 31, 2007	5
	Consolidated Statements of Cash Flows, for the three months ended March 31, 2007 and 2006	6
	Notes to Consolidated Financial Statements	8
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3	Quantitative and Qualitative Disclosures About Market Risk	17
Item 4	Controls and Procedures	18
PART II	Other Information	18
Item 1	Legal Proceedings	18
Item 1A	Risk Factors	18
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	18
Item 3	Defaults Upon Senior Securities	18
Item 4	Submission of Matters to a Vote of Security Holders	18
Item 5	Other Information	18
Item 6	Exhibits	18
	Signatures	19

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ¨ NO x

2As of May 13, 2009, there were issued and outstanding 6,589,256 shares of the registrant’s Common Stock.

PARTTable Iof FINANCIAL INFORMATIONContents

~~Item~~INDEX ~~1 Financial Statements~~

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY


PART I Financial Information			3

	Item 1	Financial Statements (Unaudited)	3

		Consolidated Statements of Financial Condition at March 31, 2009 and December 31, 2008	3

		Consolidated Statements of Operations for the Three Months Ended March 31, 2009 and 2008	4

		Consolidated Statement of Stockholders’ Equity for the Three Months Ended March 31, 2009	5

		Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2009 and 2008	6

		Notes to Consolidated Financial Statements	8

	Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

	Item 3	Quantitative and Qualitative Disclosures About Market Risk	27

	Item 4 (T)	Controls and Procedures	28

PART II Other Information			29

	Item 1	Legal Proceedings	29

	Item 1A	Risk Factors	29

	Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	29

	Item 3	Defaults Upon Senior Securities	29

	Item 4	Submission of Matters to a Vote of Security Holders	29

	Item 5	Other Information	29

	Item 6	Exhibits	29

~~Consolidated~~2 ~~Statements of Financial Condition~~

(In thousands, except per share data)	March 31, 2007			December 31, 2006*
	(Unaudited)
Assets
Cash and due from banks, noninterest-bearing	$	16,362		$	12,825
Interest-bearing deposits in other banks		1,404			4,190
Total cash and cash equivalents		17,766			17,015
Securities:
Available for sale (amortized cost of $42,951 in March 2007 and $44,079 in December 2006)		42,402			43,351
Held to maturity (estimated market value of $1,623 in March 2007 and $1,681 in December 2006)		1,671			1,738
FHLB stock		6,681			6,715
Loans held for sale		5,676			4,442
Loans		764,579			761,398
Less allowance for loan losses		8,085			7,786
Net loans		756,494			753,612
Other real estate owned		574			653
Accrued interest receivable		4,460			4,467
Premises and equipment, net		11,790			10,437
Goodwill		1,462			1,462
Other assets		16,249			16,198
Total assets	$	865,225		$	860,090
Liabilities and Stockholders' Equity
Deposits	$	665,139		$	661,892
Short-term borrowings		26,345			27,485
Escrow deposits		618			415
Accrued interest payable		496			480
Accrued expenses and other liabilities		4,430			3,659
Long-term obligations		108,658			108,536
Total liabilities		805,686			802,467
Stockholders' equity:
Preferred stock, $1 par value: 3,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $1 par value: 14,000 shares authorized, 6,517 and 6,514 issued and outstanding		6,517			6,514
Additional paid-in capital		2,935			2,909
Accumulated other comprehensive loss		(337	)		(447	)
Retained earnings		50,424			48,647
Total stockholders' equity		59,539			57,623
Total liabilities and stockholders' equity	$	865,225		$	860,090
Book value per common share	$	9.14		$	8.85

*PART ~~Derived~~I ~~from~~FINANCIAL ~~audited consolidated financial statements.~~INFORMATION

~~See~~Item ~~accompanying notes~~1 toFinancial ~~consolidated financial statements.~~ Statements

3COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

~~COOPERATIVE~~Consolidated ~~BANKSHARES,~~Statements ~~INC.~~of ~~AND~~Financial ~~SUBSIDIARY~~Condition

Consolidated Statements of Operations


(In thousands, except per share data)	March 31, 2009			December 31, 2008*
	(Unaudited)
Assets

Cash and due from banks, noninterest-bearing	$	10,031		$	7,475
Interest-bearing deposits in other banks		53,691			426

Total cash and cash equivalents		63,722			7,901

Securities:
Available for sale (amortized cost of $29,683 at March 31, 2009 and $29,746 at December 31, 2008)		30,198			30,326
Held to maturity (estimated market value of $1,265 at March 31, 2009 and $3,336 at December 31, 2008)		1,219			3,275
FHLB stock		9,317			8,330
Loans held for sale		5,575			17,015

Loans		842,922			871,196
Less allowance for loan losses		29,525			36,262

Net loans		813,397			834,934

Other real estate owned		15,199			11,104
Accrued interest receivable		3,924			3,756
Premises and equipment, net		14,378			14,686
Intangible assets		264			272
Bank-owned life insurance		1,609			11,618
Other assets		8,455			7,737

Total assets	$	967,257		$	950,954


Liabilities and Stockholders’ Equity

Deposits	$	767,818		$	695,562
Short-term borrowings		45,000			106,124
Escrow deposits		631			702
Accrued interest payable		803			563
Accrued expenses and other liabilities		3,997			4,905
Long-term obligations		128,522			123,524

Total liabilities		946,771			931,380


Stockholders’ equity:
Preferred stock, $1 par value: 3,000 shares authorized, no shares issued and outstanding at March 31, 2009 or December 31, 2008		—			—
Common stock, $1 par value: 14,000 shares authorized, 6,589 shares issued and outstanding at March 31, 2009 and December 31, 2008		6,589			6,589
Additional paid-in capital		3,472			3,469
Accumulated other comprehensive income		316			356
Common stock held in grantor trust - 23 shares in 2009 and 2008		(191	)		(191	)
Deferred compensation payable in common stock		191			191
Retained earnings		10,109			9,160

Total stockholders’ equity		20,486			19,574

Total liabilities and stockholders’ equity	$	967,257		$	950,954


Book value per common share	$	3.11		$	2.97

~~(Unaudited)~~* Derived from audited consolidated financial statements.

	Three Months EndedMarch 31,
(In thousands, except per share data)	2007		2006
Interest and dividend income:
Loans	$	14,798	$	11,649
Securities		509		513
Other		65		100
Dividends on FHLB stock		94		79
Total interest and dividend income		15,466		12,341
Interest expense:
Deposits		6,766		4,431
Short-term borrowings		244		257
Long-term obligations		1,271		1,108
Total interest expense		8,281		5,796
Net interest income		7,185		6,545
Provision for loan losses		300		585
Net interest income after provision for loan losses		6,885		5,960
Noninterest income:
Gain on sale of loans		293		340
Service charges and fees on loans		110		140
Deposit-related fees		498		474
Gain (loss) on disposal of premises and equipment		275		(1	)
Bank-owned life insurance earnings		92		96
Other income, net		59		58
Total noninterest income		1,327		1,107
Noninterest expense:
Compensation and fringe benefits		3,105		2,995
Occupancy and equipment		960		942
Professional and examination fees		177		168
Advertising		143		133
Other		527		610
Total noninterest expenses		4,912		4,848
Income before income taxes		3,300		2,219
Income tax expense		1,197		766
Net income	$	2,103	$	1,453
Net income per common share:
Basic*	$	0.32	$	0.22
Diluted*	$	0.32	$	0.22
Weighted average common shares outstanding:
Basic*		6,515		6,465
Diluted*		6,639		6,593

See accompanying notes to consolidated financial statements.

* The per share information is computed after giving retroactive effect to the 3~~-for-2~~ ~~stock split in the form of a 50% stock dividend declared on May 31, 2006.~~

SeeTable accompanyingof notes to consolidated financial statements. Contents

4COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY

~~COOPERATIVE~~Consolidated ~~BANKSHARES,~~Statements ~~INC.~~of ~~AND~~Operations ~~SUBSIDIARY~~(Unaudited)

Consolidated Statement of Stockholders' Equity


	Three Months Ended March 31,
(In thousands, except per share data)	2009			2008
Interest and dividend income:
Loans	$	11,809		$	14,547
Securities		357			609
Other		13			34
Dividends on FHLB stock		—			106

Total interest and dividend income		12,179			15,296


Interest expense:
Deposits		5,632			7,355
Short-term borrowings		432			174
Long-term obligations		1,294			1,476

Total interest expense		7,358			9,005


Net interest income		4,821			6,291
Provision for loan losses		1,991			855

Net interest income after provision for loan losses		2,830			5,436


Noninterest income:
Gain on sale of loans		932			476
Service charges and fees on loans		65			125
Deposit-related fees		531			549
Earnings on bank-owned life insurance		63			89
Other income, net		53			65

Total noninterest income		1,644			1,304


Noninterest expense:
Compensation and fringe benefits		1,677			3,259
Occupancy and equipment		1,046			1,028
Professional and consulting fees		1,013			238
FDIC premium		816			140
Advertising		69			142
(Gain) loss on other real estate owned		(52	)		215
Other		547			607

Total noninterest expense		5,116			5,629


Income (loss) before income taxes		(642	)		1,111
Income tax expense (benefit)		(1,591	)		359

Net income	$	949		$	752


Net income per common share:
Basic	$	0.14		$	0.11
Diluted	$	0.14		$	0.11

Weighted average common shares outstanding:
Basic		6,589			6,567
Diluted		6,589			6,610

~~(Unaudited)~~See accompanying notes to consolidated financial statements.

(In thousands, except per share data)	Commonstock$1 par value*		Additionalpaid-incapital		Accumulatedothercomprehensiveloss			Retainedearnings			Totalstockholders'equity
Balance, December 31, 2006	$	6,514	$	2,909	$	(447	)	$	48,647		$	57,623
Exercise of stock options		3		12		—			—			15
Tax benefit of stock options exercised		—		14		—			—			14
Other comprehensive income, net of taxes		—		—		110			—			110
Net income		—		—		—			2,103			2,103
Cash dividends ($.05 per share)		—		—		—			(326	)		(326	)
Balance, March 31, 2007	$	6,517	$	2,935	$	(337	)	$	50,424		$	59,539

*Table Since par value per share is $1, the dollar amounts in the common stock column are equal to the number of common shares.Contents

~~See~~COOPERATIVE ~~accompanying~~BANKSHARES, ~~notes~~INC. toAND ~~consolidated~~SUBSIDIARY ~~financial statements.~~

5Consolidated Statement of Stockholders’ Equity (Unaudited)

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY


(In thousands, except share and per share data)	Common Stock $1.00 Par Value*		Additional Paid-in Capital		Accumulated Other Comprehensive Income (Loss)			Common Stock Held in Grantor Trust			Deferred Compensation Payable in Common Stock		Retained Earnings		Total Stockholders’ Equity
Balance, December 31, 2008	$	6,589	$	3,469	$	356		$	(191	)	$	191	$	9,160	$	19,574
Other comprehensive loss, net of taxes		—		—		(40	)		—			—		—		(40	)
Net income		—		—		—			—			—		949		949
Stock-based compensation		—		3		—			—			—		—		3


Balance, March 31, 2009	$	6,589	$	3,472	$	316		$	(191	)	$	191	$	10,109	$	20,486

~~Consolidated~~* ~~Statement~~Since ofpar ~~Cash~~value ~~Flows~~per share is $1.00, the dollar amounts in the common stock column are equal to the number of common shares.

~~(Unaudited)~~See accompanying notes to consolidated financial statements.

	Three Months EndedMarch 31,
(In thousands)	2007			2006
Net income	$	2,103		$	1,453
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion and amortization		(4	)		(4	)
Depreciation		256			261
Gain on sale of loans		(293	)		(340	)
Deferred tax benefit		(85	)		(320	)
Loss (gain) on sales of premises and equipment		(275	)		1
Gain on sales of other real estate owned		(8	)		(28	)
Provision for loan losses		300			585
Proceeds from sales of loans		24,866			29,028
Loan originations held for sale		(25,791	)		(33,273	)
Earnings on bank-owned life insurance		(92	)		(96	)
Changes in assets and liabilities:
Accrued interest receivable		7			(67	)
Other assets		57			(111	)
Accrued interest payable		16			(18	)
Accrued expenses and other liabilities		782			131
Net cash provided (used) by operating activities		1,839			(2,798	)
Purchases of securities available for sale		(5,494	)		(1,499	)
Proceeds from maturity of securities available for sale		6,475			1,750
Repayments of mortgage-backed securities available for sale		151			173
Repayments of mortgage-backed securities held to maturity		67			73
Purchases of FHLB stock		(1,091	)		(1,066	)
Proceeds from redemption of FHLB stock		1,125			540
Loan originations, net of principal repayments		(2,923	)		(38,859	)
Proceeds from disposals of foreclosed real estate		87			44
Purchases of premises and equipment		(1,620	)		(221	)
Net cash used in investing activities		(3,223	)		(39,065	)
Net increase in deposits		3,247			26,881
Net proceeds (repayments) on short-term borrowings		(1,140	)		8,006
Repayments on long-term obligations		(1	)		(1	)
Proceeds on long-term obligations		123			—
Proceeds from issuance of common stock, net		15			54
Dividends paid		(326	)		(216	)
Net change in escrow deposits		203			198
Tax benefit of stock options exercised		14			39
Net cash provided by financing activities		2,135			34,961
Increase (decrease) in cash and cash equivalents		751			(6,902	)
Cash and cash equivalents:
Beginning of period		17,015			23,822
End of period	$	17,766		$	16,920

(Continued)Table of Contents

~~See accompanying~~COOPERATIVE ~~notes~~BANKSHARES, toINC. ~~consolidated~~AND ~~financial~~SUBSIDIARY ~~statements.~~

6Consolidated Statements of Cash Flows (Unaudited)

COOPERATIVE BANKSHARES, INC. AND SUBSIDIARY


	Three Months Ended March 31,
(In thousands)	2009			2008
Net income	$	949		$	752
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization (accretion)		(117	)		7
Depreciation		298			268
Gain on sale of loans		(932	)		(476	)
Deferred tax expense (benefit)		225			(217	)
Gain on disposal of premises and equipment		(8	)		(3	)
Gain on sales of other real estate owned		(8	)		—
Valuation adjustments on other real estate owned		(75	)		165
Provision for loan losses		1,991			855
Proceeds from sales of loans		53,063			26,621
Loan originations held for sale		(40,691	)		(26,744	)
Earnings on bank-owned life insurance		(63	)		(89	)
Stock-based compensation		3			3
Changes in assets and liabilities:
Accrued interest receivable		(236	)		453
Other assets		9,354			535
Accrued interest payable		240			3
Accrued expenses and other liabilities		(1,106	)		290

Net cash provided by operating activities		22,887			2,423


Purchases of securities available for sale		—			(19,910	)
Proceeds from maturity of securities available for sale		—			15,000
Proceeds from maturity of securities held to maturity		2,000			—
Repayments of mortgage-backed securities available for sale		61			120
Repayments of mortgage-backed securities held to maturity		57			65
Purchases of FHLB stock		(987	)		(2,370	)
Proceeds from redemption of FHLB stock		—			1,530
Loan originations, net of principal repayments		—			(22,741	)
Loan principal repayments, net of originations		15,628			—
Proceeds from disposals of foreclosed real estate		204			1
Net expenditures on foreclosed real estate		(25	)		(9	)
Purchases of premises and equipment		(4	)		(1,007	)
Proceeds from sales of premises and equipment		22			119

Net cash provided by (used in) investing activities		16,956			(29,202	)


Net increase in deposits		72,256			13,749
Net proceeds (repayments) on short-term borrowings		(66,124	)		1,407
Repayments on long-term obligations		(2	)		(2	)
Proceeds from long-term obligations		10,000			15,000
Proceeds from issuance of common stock, net		—			128
Dividends paid		—			(328	)
Net change in escrow deposits		(152	)		81
Tax benefit of stock options exercised		—			63

Net cash provided by financing activities		15,978			30,098


Increase in cash and cash equivalents		55,821			3,319

Cash and cash equivalents:
Beginning of period		7,901			13,793

End of period	$	63,722		$	17,112


(Continued)

~~Consolidated~~See ~~Statements~~accompanying ofnotes ~~Cash~~to ~~Flows~~consolidated financial statements.

~~(Continued)~~6

	Three Months EndedMarch 31,
(In thousands)	2007		2006
Cash paid for:
Interest	$	8,265	$	5,814
Income taxes		180		668
Summary of noncash investing and financing activities:
Unrealized gains (losses) on securities available for sale, net of taxes		110		(185	)
Long-term obligations reclassified to short-term borrowings		5,000		5,000
Short-term borrowings reclassified to long-term obligations		5,000		—

~~See~~COOPERATIVE ~~accompanying~~BANKSHARES, ~~notes~~INC. toAND ~~consolidated~~SUBSIDIARY ~~financial statements.~~

7Consolidated Statements of Cash Flows (Unaudited)

~~Notes~~(Continued) ~~To Consolidated Financial Statements~~

1. Accounting Policies: The significant accounting policies followed by Cooperative Bankshares, Inc. (“Bankshares”) for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. These unaudited consolidated financial statements have been prepared in accordance with Rule 10-01 of Regulation S-X, and, in management’s opinion, all adjustments of a normal recurring nature necessary for a fair presentation have been included. The accompanying consolidated financial statements do not purport to contain all the necessary financial disclosures that might otherwise be necessary in the circumstances and should be read in conjunction with the consolidated financial statements and notes thereto in Bankshares’ Annual Report on Form 10-K for the year ended December 31, 2006 (the “Annual Report”). The results of operations for the three-month period ended March 31, 2007 are not necessarily indicative of the results to be expected for the full year.


	Three Months Ended March 31,
(In thousands)	2009			2008
Cash paid for:
Interest	$	7,118		$	9,002
Income taxes		—			5

Summary of noncash investing and financing activities:
Transfer from recorded investment in loans to other real estate owned		4,191			2,997
Unrealized gains (losses) on securities available for sale, net of taxes		(40	)		96
Loans to facilitate the sale of other real estate owned		—			4,285
Long-term obligations reclassified to short-term borrowings		5,000			5,000

2.See ~~Basis of Presentation: The~~ accompanying ~~unaudited~~notes consolidated financial statements include the accounts and transactions of Bankshares, its wholly owned subsidiary, Cooperative Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, Lumina Mortgage Company, Inc. (“Lumina”) and CS&L Holdings, Inc. (“Holdings”), and Holdings’ majority owned subsidiary, CS&L Real Estate Trust, Inc. (“REIT”). Bankshares, the Bank and the Bank’s subsidiaries are collectively referred to ~~as the Company. All significant intercompany transactions have been eliminated. Bankshares wholly owns Cooperative Bankshares Capital Trust I (the “Trust”), which is not~~ consolidated ~~in these~~ financial statements ~~due to the adoption of FASB Interpretation No~~. (“FIN”) 46, “Consolidation of Variable Interest Entities.” Holdings and REIT were liquidated effective June 30, 2006, with all of their assets and liabilities transferring to the Bank. The liquidation did not have a material impact on the Company’s financial position or results of operations.

In7 September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”), “Considering the Effects of Prior Years Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. As disclosed in our 2006 Annual Report on Form 10-K filed with the SEC on March 15, 2007, we adopted SAB 108 during the quarter ended December 31, 2006 and elected to use the cumulative effect transition method in connection with the preparation of our financial statements. Quarterly data for 2006 has been restated to reflect the effect of the adjustments resulting from the adoption of SAB 108. For additional information regarding the adoption and effect of SAB 108, see Note 1 of “Notes to Consolidated Financial Statements” included in the Annual Report on Form 10-K for the year ended December 31, 2006.

OnTable May 31, 2006, the Company declared a 3-for-2 stock split in the form of a 50% stock dividend. All references to per share results and weighted average common and common equivalent shares outstanding have been adjusted to reflect the effect of this split. Certain items included in prior years’ consolidated financial statements have been reclassified to conform to the current period presentation. These reclassifications have no effect on the net income or stockholders’ equity as previously reported. Contents

~~All information in the~~ Notes toTo Consolidated Financial Statements ~~has been presented in thousands, except percentage, time period, share and per share data.~~

31. ~~Earnings~~Accounting ~~Per Share~~Policies: ~~Basic~~The ~~earnings~~significant ~~per~~accounting ~~share~~policies followed by Cooperative Bankshares, Inc. (“~~basic EPS~~Bankshares”) isfor ~~calculated~~interim byfinancial ~~dividing~~reporting ~~net~~are ~~income~~consistent bywith the ~~weighted~~accounting ~~average~~policies ~~number~~followed offor ~~common~~annual ~~shares~~financial ~~outstanding~~reporting. ~~Diluted~~These ~~earnings~~unaudited ~~per~~consolidated ~~share~~financial ~~(“diluted~~statements ~~EPS”)~~have isbeen ~~calculated~~prepared byin ~~dividing~~accordance ~~net~~with ~~income~~Rule by10-01 ~~the~~of ~~sum~~Regulation ofS-X, ~~the~~and, ~~weighted~~in ~~average~~management’s ~~number~~opinion, ofall ~~common~~adjustments ~~shares~~of ~~outstanding~~a ~~and~~normal ~~potential~~recurring ~~common~~nature ~~stock.~~necessary ~~Potential~~for ~~common~~a ~~stock~~fair ~~consists~~presentation ofhave ~~additional~~been ~~common~~included. ~~stock~~The ~~that~~accompanying ~~would~~consolidated ~~have~~financial ~~been~~statements ~~outstanding~~do asnot apurport ~~result~~to ofcontain all the ~~exercise~~necessary offinancial ~~dilutive~~disclosures ~~stock~~that ~~options.~~might Inotherwise ~~determining~~be ~~the~~necessary ~~number~~under ofall ~~shares~~circumstances ofand ~~potential~~should ~~common~~be ~~stock,~~read ~~the~~in ~~treasury~~conjunction ~~stock~~with ~~method~~the ~~was~~consolidated ~~applied.~~financial ~~This~~statements ~~method~~and ~~assumes~~notes ~~that~~thereto ~~the~~included ~~number~~in ofBankshares’ ~~shares~~Annual ~~issuable~~Report ~~upon~~on ~~exercise~~Form of10-K for the ~~stock~~year ~~options~~ended isDecember ~~reduced~~31, by2008 (the ~~number~~“Annual ofReport”), ~~common~~which ~~shares~~was ~~assumed~~filed ~~purchased~~with atthe ~~market~~Securities ~~prices~~and ~~with~~Exchange Commission (the ~~proceeds~~“SEC”) ~~from~~on ~~the~~May ~~assumed~~1, ~~exercise~~2009. The results of ~~the~~operations ~~common~~for ~~stock~~the ~~options~~three-month ~~plus~~period ~~any~~ended ~~tax~~March ~~benefits~~31, ~~received~~2009 asare anot ~~result~~necessarily indicative of the ~~assumed~~results ~~exercise~~to be expected for the full year.

82. Basis of Presentation: The accompanying unaudited consolidated financial statements include the accounts and transactions of Bankshares, its wholly owned subsidiary, Cooperative Bank (the “Bank”), and the Bank’s wholly owned subsidiary, Lumina Mortgage Company, Inc. (“Lumina”). Bankshares, the Bank, and Lumina are collectively referred to herein as the “Company.” All significant intercompany transactions have been eliminated. Bankshares wholly owns Cooperative Bankshares Capital Trust I and Cooperative Bankshares Capital Trust II, which are not consolidated in these financial statements due to the Company’s adoption of FASB Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities.”

~~The~~Certain items ~~following~~included ~~table~~in ~~presents~~the ~~net~~prior ~~income~~year’s ~~available~~consolidated tofinancial ~~common~~statements ~~stockholders~~have ~~and~~been reclassified to conform to the ~~average~~current ~~number~~year’s ofpresentation. ~~shares outstanding~~These ~~for~~reclassifications have no effect on the ~~periods~~net ~~below:~~income or stockholders’ equity as previously reported.

	Three months endedMarch 31,
	2007		2006
Net income	$	2,103	$	1,453
Shares for basic EPS		6,514,550		6,464,842
Dilutive effect of stock options		124,499		128,174
Shares for diluted EPS		6,639,049		6,593,016

All information in the “Notes to Consolidated Financial Statements” has been presented in thousands, except percentage, time period, and per share data.

~~For~~3. Earnings Per Share: Basic earnings per share (“basic EPS”) is calculated by dividing net income by the ~~periods~~weighted ~~ended~~average ~~March 31,~~number ~~2007~~of common shares outstanding. Diluted earnings per share (“diluted EPS”) is calculated by dividing net income by the sum of the weighted average number of common shares outstanding and ~~2006,~~potential ~~there~~common ~~were~~stock. noPotential ~~options~~common stock consists of additional common stock that would have been outstanding as a result of the exercise of dilutive stock options. In determining the number of shares of potential common stock, the treasury stock method was applied by the Company. This method assumes that ~~were antidilutive~~the ~~since~~number of shares issuable upon exercise of stock options is reduced by the ~~average~~number of common shares assumed purchased at market ~~price~~prices ~~exceeded~~with the proceeds from the assumed exercise ~~price~~of ~~for~~the ~~all~~common ~~outstanding~~stock options. plus any tax benefits received as a result of the assumed exercise plus any unrecognized stock-based compensation expenses.

4.The ~~Comprehensive~~following ~~Income:~~table ~~Comprehensive~~presents ~~income includes~~ net income ~~and all other changes~~ available to ~~the~~common ~~Company’s~~stockholders ~~equity,~~and ~~with~~ the ~~exception~~average ofnumber ~~transactions with shareholders (“other comprehensive income”). The Company’s only components~~ of ~~other~~shares ~~comprehensive~~outstanding ~~income~~for ~~relate~~the toperiods ~~unrealized~~below: ~~gains and losses on available for sale securities.~~

The following table sets forth the components of other comprehensive income and total comprehensive income for the three months ended March 31, 2007 and 2006:


	Three Months Ended March 31,
	2009		2008
Net income	$	949	$	752


Shares for basic EPS		6,589		6,567
Dilutive effect of stock options		—		43


Shares for diluted EPS		6,589		6,610

	Three Months EndedMarch 31,
	2007			2006
Net income	$	2,103		$	1,453
Other comprehensive income (loss):
Unrealized gain (loss) on available for sale securities		179			(301	)
Income tax benefit (expense)		(69	)		116
Other comprehensive income (loss)		110			(185	)
Comprehensive income	$	2,213		$	1,268

For the three-month periods ended March 31, 2009 and 2008, there were 266 and 148 options, respectively, that were antidilutive because the exercise price of those options exceeded the average market price of the Company’s common stock.

5.8 Stock-Based Compensation: The Company has a Stock Option Plan in effect at March 31, 2007 and recognizes related costs in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”). All options outstanding as of December 31, 2005 were fully vested and no new options have been subsequently issued. Therefore, no option related compensation cost has been charged against income for the three months ended March 31, 2007 and 2006.

9Table of Contents

~~The~~4. ~~following~~Comprehensive ~~table~~Income: ~~presents~~Comprehensive ~~information~~income ~~related~~includes net income and all other changes to the ~~stock~~Company’s ~~option~~equity, ~~plan~~with asthe exception of ~~March 31,~~transactions ~~2007~~with ~~and changes~~stockholders ~~during~~(“other ~~the~~comprehensive ~~three-month~~income ~~period~~(loss)”). ~~then~~The ~~ended:~~Company’s only components of other comprehensive income (loss) relate to unrealized gains and losses on available for sale securities.

	Shares	WeightedAverageExercisePrice		WeightedAverageRemainingContractualTerm	AggregateIntrinsicValue
Outstanding at December 31, 2006	337,425	$	8.98	5.62
Exercised	3,018		4.92	2.28
Forfeited	—		—	—
Granted	—		—	—
Outstanding at March 31, 2007	334,407	$	9.01	5.40	$	2,488
Exerciseable at March 31, 2007	334,407	$	9.01	5.40	$	2,488

The following table sets forth the components of other comprehensive income (loss) and total comprehensive income for the three months ended March 31, 2009 and 2008:

For the three months ended March 31, 2007 and 2006, the intrinsic value of options exercised was approximately $35 and $101 respectively.


	Three Months Ended March 31,
	2009			2008
Net income	$	949		$	752

Other comprehensive income (loss):
Unrealized gain (loss) on available for sale securities		(66	)		157
Income tax benefit (expense)		26			(61	)


Other comprehensive income (loss)		(40	)		96


Comprehensive income	$	909		$	848

65. ~~Recent~~Stock-Based ~~Accounting Pronouncements~~Compensation: ~~Statement~~Bankshares ofhad ~~Financial~~a ~~Accounting~~stock ~~Standards~~option ~~No.~~plan ~~159,~~in ~~“The~~effect ~~Fair~~at ~~Value~~March ~~Option~~31, ~~for~~2009 ~~Financial Assets~~ and ~~Financial~~recognized ~~Liabilities”~~related ~~(“SFAS~~costs ~~159”),~~in ~~permits~~accordance ~~entities~~with toSFAS ~~choose~~No. to123 ~~measure~~(revised ~~many~~2004), ~~financial~~“Share-Based ~~instruments~~Payment,” ~~and~~(“SFAS ~~certain~~No. ~~other items at fair value~~123R”). ~~The~~Bankshares ~~objective~~did ofnot ~~this~~issue ~~standard~~any isoptions toduring ~~improve financial reporting by providing entities with~~ the ~~opportunity~~three tomonths ~~mitigate~~ended ~~volatility~~March in31, ~~reported~~2009 ~~earnings~~or ~~caused~~2008. byOption ~~measuring~~ related ~~assets~~compensation ~~and~~cost ~~liabilities differently without having to apply complex hedge accounting provisions. This statement is effective~~ for ~~fiscal~~the ~~years~~three ~~beginning~~months ~~after~~ended ~~November~~March 1531, ~~2007,~~2009 ~~with~~and ~~early~~2008 ~~adoption~~was ~~permitted~~$3 ~~under certain circumstances. The Company has chosen not to early adopt the provision of SFAS 159. The Company has evaluated this statement~~ and ~~does~~$3, ~~not believe it will have a material effect on the Company’s consolidated financial statements~~respectively.

~~From~~The ~~time~~following totable ~~time,~~presents ~~the~~information ~~FASB~~related ~~issues exposure drafts of proposed~~to ~~statements~~Bankshares’ ofstock ~~financial~~option ~~accounting~~plan ~~standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB~~ as ~~statements~~ of ~~financial~~March 31, ~~accounting~~2009 ~~standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company~~ and ~~monitors the status of~~ changes toduring ~~and~~the ~~proposed~~three-month ~~effective~~period ~~dates~~then ofended: ~~exposure drafts.~~

7. Income Taxes: Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. The adoption of FIN 48 did not have a material effect on our consolidated financial statements.


	Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at December 31, 2008	269	$	10.31
Exercised	—		—
Expired	—		—
Forfeited	3		13.35
Granted	—		—

Outstanding at March 31, 2009	266	$	10.27	4.52	$	—


Exerciseable at March 31, 2009	256	$	10.17	4.35	$	—

8.For ~~Pending~~the ~~Acquisition:~~three Onmonths ~~March~~ended 7March 31, ~~2007~~2008, the ~~Company~~intrinsic ~~announced~~value ~~the signing~~ of aoptions ~~definitive~~exercised ~~merger~~was ~~agreement~~$187. No ~~with~~options ~~Bank~~were ofexercised ~~Jefferson~~during ~~in which Bankshares will acquire~~ the ~~net~~three ~~assets~~months ofended ~~Bank of Jefferson in an all-cash transaction. Bank of Jefferson is headquartered in Chesterfield County~~March 31, ~~South Carolina~~2009. This transaction is subject to the approval of Bank of Jefferson’s shareholders and appropriate regulatory authorities. It is expected that this transaction will be consummated by the third quarter of 2007.

~~Item~~9 ~~2 Management’s Discussion and Analysis of Financial Condition and Results of Operations~~

Forward-LookingTable Statementsof Contents

~~This~~6. ~~document,~~Fair asValue: ~~well~~In asSeptember ~~other~~2006, ~~written~~the ~~communications~~Financial ~~made~~Accounting ~~from~~Standards ~~time~~Board to(“FASB”) ~~time~~issued ~~by Cooperative~~SFAS ~~Bankshares~~No. 157, ~~Inc~~“Fair Value Measurements” (“SFAS 157”). ~~and~~SFAS ~~subsidiaries~~157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and ~~oral~~expands ~~communications~~disclosures ~~made~~about ~~from~~fair ~~time~~value tomeasurements. ~~time~~This bystandard ~~authorized~~does ~~officers~~not ofrequire any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. However, in February 2008, the ~~Company~~FASB issued FASB Staff Position 157-2 (“FSP 157-2”), ~~may~~which ~~contain~~delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements ~~relating~~on toa recurring basis. FSP 157-2 partially deferred the ~~future~~effective ~~results~~date of SFAS 157 to fiscal years beginning after November 15, 2008 for items within the scope of FSP 157-2. The Company ~~(including~~adopted ~~certain~~FSP ~~projections~~157-2 and SFAS 157 on January 1, ~~such~~2009 asand ~~earnings~~ January 1, 2008, respectively. The adoption of FSP 157-2 did not have a significant impact on the Company’s consolidated financial statements.

10Beginning January 1, 2008, the Company was able to prospectively elect to apply SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” The Company has evaluated this statement and has elected not to apply the fair value option for any financial assets or liabilities at this time, except for those already required to be measured at fair value in accordance with generally accepted accounting principles.

Under ~~projections,~~SFAS necessary tax provisions and business trends) that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). Such forward-looking statements may be identified by the use of such words as “intend157,” ~~“believe,” “expect,” “should,” “planned,” “estimated” and “potential.” For these statements,~~ the Company ~~claims~~groups ~~the~~assets ~~protection of the safe harbor for forward-looking statements contained in the PSLRA. The Company’s ability to predict future results is inherently uncertain~~ and ~~the~~liabilities ~~Company~~at ~~cautions~~fair ~~you~~value ~~that~~into athree number of important factors could cause actual results to differ materially from those currently anticipated in any forward-looking statement. These factors include among others; changes in market interest rates and general and regional economic conditionslevels, ~~changes~~based inon ~~government regulations, changes in accounting principles and~~ the ~~quality~~markets ~~or composition of the loan and investment portfolios. Additional factors that may affect our results are discussed under “Item 1A. Risk Factors”~~ in ~~the~~which ~~Company’s quarterly reports on Form 10-Q and in its annual report on Form 10-K, each filed with~~ the ~~Securities~~assets and ~~Exchange~~liabilities ~~Commission, which~~ are ~~available~~traded ~~at the Securities~~ and ~~Exchange Commission’s Internet website (www.sec.gov) and to which reference is hereby made. These factors should be considered in evaluating~~ the ~~forward-looking~~reliability ~~statements. Stockholders are cautioned not to place undue reliance on such statements, which speak only as~~ of the ~~date~~assumptions ofused ~~those documents. All subsequent written and oral forward-looking statements attributable~~ to usdetermine orfair ~~any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above~~value. ~~Except~~These ~~to the~~levels extent required by applicable law or regulation, the Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are ~~made.~~:

~~General~~Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.

~~Cooperative~~Level ~~Bankshares,~~2 Valuation ~~Inc. (“Bankshares”)~~ is abased ~~registered~~upon ~~bank~~quoted ~~holding~~prices ~~company~~for ~~incorporated~~similar ininstruments ~~North Carolina~~ in ~~1994. Bankshares is the parent company of Cooperative Bank (the “Bank”), a North Carolina chartered~~active ~~commercial bank. Cooperative Bank~~markets, ~~headquartered~~quoted inprices ~~Wilmington,~~for ~~North~~identical ~~Carolina,~~or ~~was~~similar ~~chartered~~instruments in ~~1898.~~markets Asthat ofare ~~March 31,~~not ~~2007~~active, ~~the~~and ~~Bank~~model-based ~~provides~~valuation ~~financial~~techniques ~~services~~for ~~through~~which 21all ~~offices~~significant inassumptions ~~Eastern~~are ~~North~~observable ~~Carolina. The Bank opened its 22nd branch on April 2, 2007~~ in ~~Leland,~~the ~~NC, a suburb of Wilmington~~market.

~~One~~Level of3 Valuation ~~the~~is ~~Bank’s~~generated ~~subsidiaries,~~from ~~Lumina~~model-based ~~Mortgage~~techniques ~~Company,~~that ~~Inc.~~use ~~(“Lumina”)~~at isleast aone ~~mortgage~~significant ~~banking~~assumption ~~firm originating and selling residential mortgage loans~~not ~~through~~observable ~~two offices~~ in ~~North~~the ~~Carolina~~market. ~~Lumina~~These ~~closed~~unobservable ~~its~~assumptions ~~Charlotte,~~reflect ~~North~~estimates ~~Carolina~~of ~~office~~assumptions onthat ~~March 30,~~market ~~2007.~~participants ~~The~~would ~~Bank~~use ~~liquidated its other subsidiary, CS&L Holdings, Inc. (“Holdings”), a holding company incorporated~~ in ~~Virginia for~~pricing ~~CS&L Real Estate Trust, Inc. (~~the ~~“REIT”),~~asset aor ~~real estate investment trust, which was also liquidated~~liability. ~~Holdings~~Valuation ~~and~~techniques ~~REIT~~include ~~were~~use ~~liquidated~~of ~~effective~~option ~~June 30,~~pricing ~~2006~~models, ~~with~~discounted ~~all~~cash offlow ~~their assets and liabilities transferring to the~~models ~~Bank. Bankshares, the Bank~~ and ~~the~~similar ~~Bank’s subsidiaries are collectively referred to as the Company~~techniques. ~~The liquidation of Holdings and REIT did not have a material impact on the Company’s financial position or results of operations.~~

~~Through~~Securities ~~its~~available ~~offices,~~for ~~the~~sale ~~Bank~~are ~~provides~~recorded aat ~~wide~~fair ~~range~~value ofon ~~banking~~a ~~products,~~recurring ~~including~~basis. ~~interest-bearing~~Fair ~~and~~value ~~noninterest-bearing~~measurement ~~checking~~is ~~accounts,~~based upon ~~certificates~~quoted ofmarket ~~deposit, savings accounts and individual retirement accounts~~prices. ItLevel ~~offers~~2 ansecurities ~~array~~include ~~of loan products: overdraft protection, commercial, consumer, agricultural, real estate, residential~~ mortgage-backed ~~and~~securities ~~home equity loans. Also offered are safe deposit boxes~~ and ~~automated~~bonds ~~banking~~issued ~~services~~by ~~through~~government ~~Online~~sponsored ~~Banking, Bill Payment, ATMs and Access24 Phone Banking~~entities. InThe ~~addition,~~Company ~~the~~did ~~Bank’s~~not ~~third~~sell ~~party~~any ~~partnership~~of ~~with~~its ~~Seagate~~securities ~~Wealth~~available ~~Management~~for ~~Group~~sale ~~through~~during ~~UVEST~~the ~~Investment~~quarters ~~Services gives~~ended ~~clients access to a wide array of financial~~March ~~& wealth management solutions~~31, ~~including~~2009 ~~services~~or ~~such~~2008 and ~~as professional money management~~therefore, ~~retirement~~changes ~~and~~in ~~education~~the ~~planning~~fair ~~and~~value ~~investment~~of ~~products~~securities ~~including~~available ~~stocks,~~for ~~bonds,~~sale ~~mutual~~have ~~funds, annuities~~not ~~and~~been ~~insurance~~recorded ~~products~~through earnings.

~~Mission~~As ~~Statement~~a part of its normal business operations, the Company originates mortgage loans that have been approved by secondary investors. The terms of the loans are set by the secondary investors and are transferred within several weeks of the Company initially funding the loan. Between the initial funding of the loans by the Company and the subsequent purchase by the investor, the Company carries the loans on its balance sheet at cost, which approximates fair value due to the short duration of time between loan funding and subsequent sale. If, at any time, the Company determines that the fair value of any loan held for sale is less than its cost, an adjustment is made to carry such loans at fair value. From time to time, the Company may transfer loans held for investment to loans held for sale. The Company carries these loans at the lower of cost or fair value. The fair value of loans held for sale is based on the price secondary market investors are currently offering for loans with similar characteristics. Therefore, the Company classifies loans available for sale, subject to nonrecurring fair value adjustments, as Level 2. The Company did not recognize any gains or losses related to the change in the fair value of loans held for sale during the quarters ended March 31, 2009 or 2008.

ItThe isCompany ~~the~~does ~~mission~~not ofrecord ~~the~~loans ~~Company~~at tofair ~~provide~~value ~~the~~on ~~maximum~~a inrecurring ~~safety~~basis. ~~and~~However, ~~security~~loans considered ~~for our depositors~~impaired, anwithin ~~equitable~~the ~~rate~~definition of ~~return~~SFAS No. 114, “Accounting by Creditors for ~~our~~Impairment ~~stockholders~~of a Loan,” ~~and~~are ~~excellent~~individually ~~service~~evaluated for ~~our~~impairment. ~~customers,~~Under ~~and~~SFAS toNo. 114, doa soloan ~~while~~is ~~operating~~considered inimpaired, abased ~~fiscally~~on ~~sound~~current information and ~~conservative manner~~events, ~~with~~if ~~fair~~it ~~pricing~~is ofprobable ~~our~~that ~~products~~the ~~and~~Company ~~services,~~will ~~good~~be ~~working~~unable ~~conditions,~~to ~~outstanding~~collect ~~training~~the payments of principal and ~~opportunities~~interest ~~for~~according ~~our~~to ~~staff,~~the ~~along~~terms ~~with~~of athe ~~high~~original ~~level~~loan agreement. Uncollateralized loans are measured for impairment based on the present value of ~~corporate~~expected ~~citizenship.~~future cash flows discounted at the original contractual interest rate,

~~Management~~10 ~~Strategy~~

TheTable Bank’s lending activities have traditionally concentrated on the origination of loans for the purpose of constructing, financing or refinancing residential properties. In recent years the Bank has emphasized the Contents

11 while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. The Company recognizes changes in the fair value of impaired loans through adjustments to the allowance for loan losses or by charging off the impaired portion of the loan if it is deemed uncollectible.

The Company records written loan commitments at fair value on ~~origination~~a ofrecurring ~~nonresidential~~basis ~~real~~in ~~estate~~accordance ~~loans,~~with ~~equity~~Staff ~~lines~~Accounting ofBulletin ~~credit~~No. 109, ~~and~~“Written ~~secured~~Loan ~~and~~Commitments ~~unsecured~~Recorded ~~consumer~~at ~~and~~Fair ~~business~~Value ~~loans~~Through Earnings.” AsThese ofassets ~~March 31,~~are ~~2007, $575.7~~classified ~~million,~~as orrecurring 75Level 3.~~1%,~~ ofThe ~~the~~fair ~~Bank’s~~value of written loan ~~portfolio,~~commitments is ~~which~~recorded ~~excludes~~based ~~loans~~on ~~held~~the ~~for~~anticipated ~~sale,~~gain ~~consisted~~on ofthose ~~loans~~commitments ~~secured~~outstanding byexpected ~~residential~~to ~~properties~~fund. asGains ~~compared~~and losses related to ~~$557.3~~the ~~million,~~change orin ~~73.0%,~~fair atvalue ~~December 31,~~of ~~2006.~~written ~~The~~loan ~~Bank~~commitments ~~originates~~are ~~adjustable rate~~recorded ~~and~~through ~~fixed~~earnings ~~rate~~as ~~loans.~~gain Ason sale of ~~March 31,~~loans. ~~2007,~~The ~~adjustable~~Company recognized ~~rate~~a ~~and~~gain ~~fixed~~on ~~rate~~written ~~loans~~loan ~~totaled~~commitments ~~67.7%~~of $46 and ~~32.3%,~~$116 ~~respectively,~~for of the ~~Bank’s~~quarter ~~total~~ended ~~loan~~March 31, ~~portfolio~~2009 and 2008, respectively.

~~The~~Other ~~Bank~~real estate ~~has~~owned ~~chosen~~is recorded at the estimated fair value of the property less estimated costs to sell. aFair ~~large~~value ~~percentage~~is based upon independent market prices, appraised values of ~~its~~the ~~fixed~~collateral, ~~rate~~or ~~mortgage~~management’s ~~loan~~estimation ~~originations~~of inthe value of the collateral. ~~secondary~~When the fair value of the collateral is based on an observable market ~~and~~price ~~through~~or ~~brokered~~a ~~arrangements~~current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. ~~This~~When ~~enables~~an appraised value is not available or management determines the ~~Bank~~fair tovalue ~~invest~~of ~~these~~the ~~funds~~collateral inis ~~commercial~~further ~~loans~~impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3. Adjustments to the fair value of other real estate ~~while~~owned ~~increasing~~are ~~fee~~recorded ~~income~~through ~~and~~earnings ~~reducing~~as ~~interest~~gain ~~rate~~/ ~~risk~~loss on other real estate owned. The Company recorded a gain of $76 on fair value adjustments of other real estate owned for the quarter ended March 31, 2009 compared to a loss of $165 for the quarter ended March 31, 2008.

OnThe ~~March 7,~~table ~~2007,~~below ~~the~~presents ~~Company announced~~ the ~~signing~~recorded ofinvestment ~~a definitive merger agreement with Bank of Jefferson~~ in ~~which Bankshares will acquire the net~~ assets ofmeasured ~~Bank~~at offair ~~Jefferson~~value inon ana ~~all-cash~~recurring ~~transaction.~~basis at ~~Bank of Jefferson is headquartered in Chesterfield County~~March 31, ~~South Carolina~~2009. ~~This~~No ~~transaction~~liabilities isare ~~subject~~recorded toat ~~the~~fair ~~approval~~value ofon ~~Bank~~a ~~of Jefferson’s~~recurring ~~shareholders and appropriate regulatory authorities~~basis. ~~This acquisition gives the Company the opportunity to move into the Grand Strand area of South Carolina. It is expected that this transaction will be consummated by the third quarter of 2007.~~

Interest Rate Sensitivity Analysis


	Total		Level 1		Level 2		Level 3
Securities available for sale	$	30,198	$	—	$	30,198	$	—
Written loan commitments		110		—		—		110


Total assets at fair value	$	30,308	$	—	$	30,198	$	110

~~Interest~~The ~~rate~~table ~~sensitivity~~below ~~refers~~presents to the ~~change~~recorded ininvestment ~~interest spread resulting from changes~~ in ~~interest~~assets ~~rates.~~measured To the extent that interest income and interest expense do not respond equally to changes in interest rates, or that all rates do not change uniformly, earnings will be affected. Interest rate sensitivity, at afair ~~point~~value inon ~~time, can be examined using~~ a ~~static gap analysis that measures the match in balances subject to repricing between interest-earning assets and interest-bearing~~recurring ~~liabilities.~~basis Gap is considered positive when interest rate sensitive assets exceed interest rate sensitive liabilities. Gap is considered negative when interest rate sensitive liabilities exceed interest rate sensitive assets. At March 31, 2007, the Company had a one-year positive gap position of 7.7% compared to a positive gap position of 4.8% at December 31, ~~2006~~2008. ~~During~~No aliabilities period of rising interest rates, a positive gap would tend to result in an increase in net interest income, while a negative gap would tend to adversely affect net interest income. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. It is important to note that certain shortcomings are ~~inherent~~recorded inat ~~static~~fair ~~gap~~value ~~analysis.~~on ~~Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. For example,~~ a ~~part~~recurring ~~of the Company’s adjustable-rate mortgage loans have been indexed to the National Monthly Median Cost of Funds ratio for the Office of Thrift Supervision regulated institutions~~basis. This index is considered a lagging index that may lag behind changes in market rates. The one-year or less interest-bearing liabilities also include checking, savings and money market deposit accounts. Historically, the Company experienced relatively modest repricing on these types of transaction accounts. Management takes this into consideration in determining acceptable levels of interest rate risk.

When Lumina gives a rate lock commitment to a customer, there is a concurrent “lock in” for the loan with a secondary market investor under a best efforts delivery mechanism. Therefore, interest rate risk is mitigated because any commitment to fund a loan available for sale is concurrently hedged by a commitment from an investor to purchase the loan under the same terms. Loans originated by Lumina are usually sold within 60 days after closing.


	Total		Level 1		Level 2		Level 3
Securities available for sale	$	30,326	$	—	$	30,326	$	—
Written loan commitments		64		—		—		64


Total assets at fair value	$	30,390	$	—	$	30,326	$	64

~~Liquidity~~11

TheTable Company’s goal is to maintain adequate liquidity to meet potential funding needs of loan and deposit customers, pay operating expenses and meet regulatory liquidity requirements. Maturing securities, principal repayments of loans and securities, proceeds from loan sales, growth in deposits, income from operations and borrowings are the main sources of liquidity. The Bank has been granted a line of credit by the Federal Home Loan Bank of Atlanta (“FHLB”) in an amount of up to 25% of the Bank’s total assets. At March 31, 2007, the Bank’s borrowed funds from the FHLB equaled 13.2% of its total assets. Scheduled loan repayments are a relatively predictable source of funds, unlike deposits and loan prepayments that are significantly influenced by general interest rates, economic conditions and competition. The Bank also made use of $1.9 million in brokered deposits obtained during the quarter ended March 31, 2007 as compared to $10.1 million obtained during the quarter ended March 31, 2006. The increased use of brokered deposits primarily results from management’s belief that these deposits were the best means to augment organic deposit origination to fund our loan growth. Contents

12The table below presents a reconciliation from December 31, 2008 to March 31, 2009 of Level 3 assets recorded on a recurring basis:

At March 31, 2007, the estimated market value of liquid assets (cash, cash equivalents, marketable securities and loans held for sale) was approximately $67.5 million, which represents 8.4% of deposits and borrowed funds, compared to $66.5 million or 8.3% of deposits and borrowed funds at December 31, 2006. The increase in liquid assets was primarily due to an increase in cash and loans held for sale, partially offset by a decrease in securities available for sale.


Recurring Level 3 Item	Beginning Balance, December 31, 2008		Gains and Losses Included in Earnings		Gains and Losses Reported Through Change in Net Assets		Purchases, Sales, Issuances, and Settlements, Net			Net Transfer In (Out) of Level 3		Ending Balance, March 31, 2009
Written loan commitments	$	64	$	110	$	—	$	(64	)	$	—	$	110

The ~~Bank’s~~table ~~primary~~below ~~uses~~presents ofa ~~liquidity are~~reconciliation tofrom ~~fund loans and to purchase investments. Management considers current liquidity levels adequate to meet the Bank’s cash flow requirements. However~~December 31, if2007 ~~loan portfolio growth exceeds deposit origination growth as it has in the past, management may need~~ to ~~increase the bank’s utilization of funding sources~~March 31, ~~such~~2008 ~~as an increased use~~ of Level ~~brokered~~3 ~~deposits,~~assets ~~additional~~recorded ~~borrowings~~on ora ~~loan~~recurring ~~sales.~~basis:

Off-Balance Sheet Arrangements and Contractual Commitments


Recurring Level 3 Item	Beginning Balance, December 31, 2007		Gains and Losses Included in Earnings		Gains and Losses Reported Through Change in Net Assets		Purchases, Sales, Issuances, and Settlements, Net		Net Transfer In (Out) of Level 3		Ending Balance, March 31, 2008
Written loan commitments	$	—	$	116	$	—	$	—	$	—	$	116

AtThe table below presents the recorded investment in assets measured at fair value on a nonrecurring basis at March 31, ~~2007,~~2009. ~~outstanding~~Impaired ~~off-balance~~loans ~~sheet~~reported ~~commitments~~at tofair ~~extend credit~~value ~~totaled~~are ~~$109.4~~classified ~~million,~~as nonaccrual and are measured at cost with a corresponding valuation allowance, such that the ~~undisbursed~~net ~~portion~~amount ofis ~~construction~~representative ~~loans~~of ~~was~~fair ~~$94~~value.3 ~~million.~~When ~~The~~an impaired ~~Bank~~loan ~~continued~~measured toat befair ~~obligated~~value towith ~~make~~a ~~future~~valuation ~~payments~~allowance ~~under~~is ~~contracts~~partially or entirely deemed uncollectible, ~~such~~the asuncollectible ~~debt~~portion ~~and~~of ~~lease~~the ~~agreements~~loan is charged off, such that the ~~amounts~~adjusted loan basis is representative of ~~which~~fair ~~were~~value. ~~consistent~~The balance of impaired loans with ~~the~~no ~~amounts~~corresponding valuation allowance totals $8,332 at ~~December~~March 31, ~~2006~~2009 ~~other~~and ~~than~~is ~~the~~not ~~decrease~~included in ~~borrowed~~the ~~funds~~table ~~of $1~~below.0 ~~million~~Of ~~and~~our ~~the~~recorded ~~increase~~investment in ~~deposits~~Level of2 $and Level 3.2 ~~million~~impaired loans measured at ~~March 31~~fair value, ~~2007.~~the ~~For~~Company ~~further~~maintains ~~information~~a corresponding onvaluation ~~the~~allowance ~~Bank’s~~in ~~off-balance~~the ~~sheet~~amounts ~~arrangements~~of $76 and ~~contractual~~ ~~commitments~~$8,722, ~~see~~respectively. ~~the~~No ~~discussion~~liabilities ~~regarding~~are ~~deposits~~recorded ~~in “Financial Condition~~ at ~~March 31,~~fair ~~2007~~value ~~compared~~on toa ~~December 31,~~nonrecurring ~~2006~~basis.”

Capital


	Total		Level 1		Level 2		Level 3
Loans held for sale	$	5,575	$	—	$	5,575	$	—
Impaired loans		54,536		—		270		54,266
Other real estate owned		15,199		—		2,839		12,360


Total assets at fair value	$	75,310	$	—	$	8,684	$	66,626

~~Stockholders’ equity at March 31, 2007, was $59.5 million, up 3.3% from $57.6 million at December 31, 2006.~~ The ~~improved~~ ~~capital~~table ~~position~~below atpresents ~~March 31, 2007 reflects~~ the ~~impact~~recorded ofinvestment ~~earnings~~in ~~retention~~assets ~~after~~measured ~~the declaration of cash dividends of $326,000. Stockholders’ equity~~ at ~~March 31,~~fair ~~2007~~value ~~includes~~on ~~an unrealized loss net of tax of $337,000,~~a ~~compared~~nonrecurring tobasis ~~an unrealized loss net of tax of $447,000~~ at ~~December~~March 31, ~~2006,~~2008: ~~on securities available for sale marked to estimated fair market value.~~

Under the capital regulations of the Federal Deposit Insurance Corporation (“FDIC”), the Bank must satisfy minimum leverage ratio requirements and risk-based capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (“Tier I”) capital to average adjusted assets of at least 3% if a particular institution has the highest examination rating and at least 4% for all others. At March 31, 2007, the Bank’s leverage capital ratio was 8.64%. The FDIC’s risk-based capital rules require banks supervised by the FDIC to maintain risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is defined as Tier I capital plus the balance of the allowance for loan losses. At March 31, 2007, the Bank had a ratio of qualifying total capital to risk-weighted assets of 11.14%.


	Total		Level 1		Level 2		Level 3
Loans held for sale	$	17,015	$	—	$	17,015	$	—
Impaired loans		42,618		—		53		42,565
Other real estate owned		11,104		—		—		11,104


Total assets at fair value	$	70,737	$	—	$	17,068	$	53,669

~~Bankshares~~7. Benefit Plans: In 2002, asthe Bank implemented a ~~bank~~non-qualifying ~~holding~~deferred ~~company,~~compensation isplan ~~also~~for ~~subject,~~certain onkey aexecutive ~~consolidated~~officers. ~~basis,~~The toBank ~~the~~has ~~capital~~purchased ~~adequacy~~life ~~guidelines~~insurance ofpolicies on the ~~Board~~participating ofofficers ~~Governors~~in oforder ~~the~~to ~~Federal~~provide ~~Reserve~~future ~~(the~~funding ~~“Federal~~of ~~Reserve~~benefit ~~Board”)~~payments. ~~The~~Benefits ~~capital~~for ~~requirements~~each ofofficer participating in the ~~Federal~~ ~~Reserve~~plan ~~Board~~accrue ~~are~~and ~~similar~~vest toduring ~~those~~the period of ~~the~~employment, ~~FDIC~~and ~~governing~~are paid in monthly benefit payments over the ~~Bank.~~participant’s life after

At12 March 31, 2007 Bankshares exceeds all of its capital requirements. With the purchase of the Bank of Jefferson, Bankshares may need to undertake capital raising measures such as issuing additional junior subordinated debentures. If this is necessary, management does not believe this would alter current operations or strategies. In addition, if the Bank continues to grow at a pace similar to the growth experienced over the past couple years, Bankshares may need to undertake similar capital raising measures to supplement risk-based capital.

OnTable February 28, 2007, the Company’s Board of Directors approved a quarterly cash dividend of $.05 per share that was paid on April 17, 2007 to stockholders of record as of April 1, 2007. Any future payment of dividends is dependent on the financial condition and capital needs of the Company, requirements of regulatory agencies and economic conditions in the marketplace. Contents

13retirement. The plan also provides for payment of disability or death benefits in the event a participating officer becomes permanently disabled or dies prior to attainment of retirement age. If the Bank has a change in control before the officer reaches age 65, the participating officer will be entitled to a benefit. Provisions of $33 and $75 were expensed for future benefits to be provided under this plan for the quarters ended March 31, 2009 and 2008, respectively. The total liability under this plan was $939 and $906 at March 31, 2009 and December 31, 2008, respectively, and is included in accrued expenses and other liabilities in the accompanying consolidated statements of financial condition. During the quarter ended March 31, 2009, this plan was modified and benefits were frozen with all applicable executive officers and the Company does not expect any additional provision for the year ended December 31, 2009.

~~Critical~~Bankshares ~~Accounting~~and ~~Policies~~the Bank have each entered into separate Director Deferred Fee Agreements with each non-employee director. Effective January 1, 2009, the Director Deferred Agreements have been amended such that interest on deferred fees is credited at a rate of 0%. In addition to this change, the Board has decided not to defer their fees beginning in January 2009. Prior to these changes, interest on the amount deferred was credited at a rate of 10%. Commencing one month after retirement at or after age 72, each director will be entitled to receive the balance in his deferral account in 120 monthly installments. Under these agreements, in the event of a change in control, each director will be entitled to receive, in lump sum payments, the greater of his deferral account balances or $170 under his agreement with the Bank and $77 under his agreement with Bankshares. The total expense incurred by the Company for these agreements was $0 and $58 for the quarters ended March 31, 2009 and 2008, respectively. The total liability under these agreements was $1,144 and $1,151 at March 31, 2009 and December 31, 2008, respectively.

~~The~~In ~~Bank’s~~September ~~most~~2006, ~~significant~~the Emerging ~~critical~~Issues ~~accounting~~Task ~~policies~~Force ~~are~~(“EITF”) ~~those~~issued ~~that~~EITF ~~govern~~06-4, ~~accounting~~“Accounting for ~~allowance~~Deferred ~~for~~Compensation ~~loan losses~~ and ~~goodwill.~~Postretirement ABenefit ~~critical~~Aspects ~~accounting~~of ~~policy~~Endorsement isSplit-Dollar ~~one~~Life ~~that~~Insurance isArrangements.” ~~both~~The ~~very~~scope ~~important~~of toEITF ~~the~~06-4 ~~portrayal~~is oflimited to the ~~Company’s~~recognition ~~financial~~of ~~condition~~a liability and ~~results~~related ofcompensation ~~operations~~costs ~~and~~for ~~requires~~endorsement asplit-dollar ~~difficult,~~life ~~subjective~~insurance orpolicies ~~complex~~that ~~judgment~~provide bya ~~management.~~benefit ~~What~~to ~~makes~~an ~~these~~employee ~~judgments~~that ~~difficult,~~extends ~~subjective~~to ~~and/or~~postretirement ~~complex~~periods. isTherefore, ~~the~~EITF ~~need~~06-4 towould ~~make~~not ~~estimates~~apply ~~about~~to ~~the~~a ~~effects~~split-dollar oflife ~~matters~~insurance arrangement that ~~are~~provides ~~inherently~~a ~~uncertain.~~specified ~~For~~benefit ~~further~~to ~~information~~an onemployee ~~the~~that ~~allowance~~is ~~for~~limited ~~loan~~to ~~losses,~~the ~~see~~employee’s ~~the~~active ~~“Critical~~service ~~Accounting~~period ~~Policies”~~with ~~and~~an employer. During the ~~“Financial~~first ~~Condition”~~quarter inof ~~Management’s~~2009, ~~Discussion~~the ~~and~~Company, ~~Analysis~~in ~~and~~agreement ~~Note~~with 1the directors and applicable ~~Note~~executives, 3elected ~~of “Notes~~ to ~~Consolidated~~surrender ~~Financial~~bank-owned ~~Statements”~~life ~~included~~insurance inpolicies ~~the~~for ~~Annual~~which ~~Report~~funds onof ~~Form~~ $10-K,072 ~~filed~~were ~~with~~received. ~~the~~Concurrent ~~SEC~~with onthis ~~March 15~~election, ~~2007.~~the ~~For~~Company ~~further~~reversed ~~information~~its onEITF ~~goodwill,~~06-4 ~~see~~liability. ~~the~~Net ~~“Critical~~related ~~Accounting~~compensation ~~Policies”~~income ~~in Management’s~~for ~~Discussion~~the ~~and~~quarter ~~Analysis~~ended March 31, ~~and~~2009 ~~Note~~was $1,116 ofcompared ~~“Notes~~ to ~~Consolidated~~net ~~Financial~~related ~~Statements”~~compensation ~~included~~cost infor the ~~Annual~~quarter ~~Report~~ended ~~on Form 10-K filed with the SEC on~~ March 1531, ~~2007~~2008 of $40.

~~FINANCIAL~~8. ~~CONDITION~~Regulatory ATAction ~~MARCH~~and ~~31,~~Going ~~2007~~Concern ~~COMPARED TO DECEMBER 31, 2006~~ Consideration:

~~The~~Regulatory ~~Company’s~~Action total assets increased 0.6% to $865.2 million at March 31, 2007, compared to $860.1 million at December 31, 2006. Asset growth was primarily attributable to an increase of $3.2 million, or 0.4%, in loans. Loan growth was funded primarily by increases in deposits of $3.2 million or 0.5%. The increase in loans and deposits was primarily the result of continued loan and deposit growth attributable to the markets in which the Bank conducts its business, the Bank’s expanded and improved branch network and the Bank’s continued emphasis on increasing overall loan production. The increase in deposits was mainly due to growth in the thirteen month certificate due to the Bank offering a competitive promotional rate on a reasonably short term deposit in an effort to foster deposit growth. In addition, the Bank increased brokered deposits by $1.9 million during the three-month period as discussed under “Liquidity”. The majority of the loan growth occurred in construction and land development loans, which grew $4.8 million (2.9%) to $170.6 million from December 31, 2006, and multi-family residential loans, which grew $5.6 million (35.1%) to $21.7 million from December 31, 2006. Investment securities, both available for sale and held to maturity portfolios, decreased $1.0 million from $45.1 million to $44.1 million, or 2.3%, as proceeds from the repayment of securities were used to increase cash and cash equivalents by $800,000 and to purchase premises and equipment.

AtAs ~~March 31,~~disclosed ~~2007,~~in ~~the~~Note ~~Bank’s~~18 ~~allowance for loan losses was $8.1 million, or 1.06%~~ of ~~loans,~~the ~~compared~~“Notes to ~~$7.8~~Consolidated ~~million,~~Financial orStatements” ~~1.02%~~included ofin the ~~loans, at December 31, 2006. The~~ Company’s ~~nonperforming~~2008 ~~assets~~Annual ~~(nonaccrual~~Report ~~loans,~~on ~~loans~~Form ~~90 days or more delinquent and foreclosed real estate) were $1.8 million~~10-K, oron ~~0.21% of assets, at~~ March 3112, ~~2007,~~2009 ~~compared~~the toBank ~~$1.9~~entered ~~million,~~into ora ~~0.23%~~Stipulation ofand ~~assets,~~Consent atto ~~December 31,~~the ~~2006.~~Issuance ~~Foreclosed~~of ~~real~~an ~~estate~~Order ~~decreased~~ to ~~$574,000~~Cease ~~at March 31, 2007, from $653,000 at December 31, 2006,~~ and isDesist ~~made up of one ocean front lot which must have mature vegetation on~~ (the ~~lot’s~~“Order”) ~~dunes~~with ~~before~~ the ~~property~~Federal ~~can~~Deposit beInsurance ~~developed.~~Corporation ~~The~~and ~~remaining decrease in nonperforming assets was primarily~~ the ~~result of a decrease in delinquencies 90 days or more past due. The increase in the~~ ~~ratio~~North ofCarolina ~~allowance~~Commissioner ~~for loan losses to loans was due to the softening~~ of ~~the economy and the concentration of loans secured by commercial real estate~~Banks. ~~Management~~Additionally, ~~considers~~effective ~~the~~April 29, ~~current level of the allowance to be appropriate based on loan composition~~2009, the ~~current level of delinquencies and other nonperforming assets, overall economic conditions and other factors. The~~ Company ~~assumes~~also anentered ~~aggressive~~into ~~position~~a inwritten ~~collecting~~agreement ~~delinquent~~with ~~loans~~the ~~and~~Federal ~~disposing~~Reserve ofBank ~~foreclosed assets to minimize balances~~ of ~~nonperforming~~Richmond ~~assets~~designed ~~and continues~~ to ~~evaluate~~enhance the ~~loan~~Company’s ~~and~~ability ~~real estate portfolios~~ to ~~provide~~act ~~loss reserves~~ as ~~considered~~a ~~necessary.~~source ~~For further information, see “Comparison~~ of strength ~~Operating~~to ~~Results~~the ~~– Provision and Reserve for Loan Losses~~Bank.”

~~Net~~The ~~premises~~Company ~~and equipment increased $1.4 million, or 13.0%, to $11.8 million at March 31, 2007 compared to $10.4 million at December 31, 2006. This increase~~ is ~~attributable~~continuing ~~primarily~~its toefforts ~~purchases made relating~~ to ~~the~~comply ~~opening~~with of the ~~Leland~~requirements ~~branch and the purchase~~ of these two ~~adjoining~~agreements ~~lots~~ in ~~Whiteville,~~accordance ~~North~~with ~~Carolina, which may be used for a branch relocation. Other~~the ~~assets~~applicable ~~increased~~prescribed ~~$51,000, or 0~~deadlines.~~3%,~~ to $16.2 million mostly due to an increase in funds being held by attorneys to fund loan closings and prepaid expenses. Loans held for sale, which are funded by and collateralize a short-term borrowing at another financial institution, increased $1.2 million, or 27.8%, since December 31, 2006 to $5.7 million at March 31, 2007.

~~Borrowed~~Going ~~funds~~Concern ~~at March 31,~~Consideration 2007, which are collateralized through an agreement with the FHLB for advances and loans held for sale, decreased $1.0 million, or 0.7%, since December 31, 2006. The FHLB advances are secured by the Bank’s investment in FHLB stock and qualifying first mortgage loans.

14Due to the conditions and events discussed throughout the 2008 Annual Report on Form 10-K, management believe substantial doubt exists as to the Bank’s ability to continue as a going concern. Management is taking various steps designed to improve the Bank’s capital position. The Bank has developed a written alternative capital plan designed to solicit capital investments and, if necessary, reduce the Bank’s asset size and expenses. Such plan is dependent upon a capital infusion to meet the capital requirements of the Order. As of the filing of this Report, the Bank is revising its capital plan to incorporate the results of the steps management has taken to improve the Bank’s capital position and the strategies it has developed to further those efforts. The Bank’s capital plan is subject to the approval of the FDIC and the North Carolina Commissioner of Banks. As of the filing of this Report, the plan has not been approved by either the FDIC or the North Carolina Commissioner of

~~Accrued~~13 expenses and other liabilities increased $771,000 (21.1%) to $4.4 million at March 31, 2007 compared to $3.7 million at December 31, 2006. Accrued federal and state income taxes and accrued expenses relating to the opening of the Leland branch are the primary reasons for the increase in accrued expenses and other liabilities during the first quarter of 2007.

COMPARISONTable OFof OPERATING RESULTS Contents

~~Overview~~ Banks. The Company continues to work with its advisors in an attempt to improve capital ratios through asset sales and/or a capital raise. As of the date of the filing of this Form 10-Q, the Company has not entered into a definitive agreement regarding the raising of additional capital or a potential sale of the Company or the Bank’s assets and no assurances can be made that the Company will ultimately enter into such an agreement.

The ~~net~~Order ~~income~~requires the Bank to increase its capital ratios so that the Bank has a minimum Tier 1 Core Capital ratio of 6% and a minimum Total Risk-Based Capital ratio of 10% within 120 days of the date of the Order. If the Company ~~depends~~does ~~primarily~~not ~~upon~~obtain ~~net~~additional ~~interest~~capital, ~~income~~management does not expect to meet the ratios set forth in the Order. ~~Net~~Failure to ~~interest~~meet ~~income~~the minimum ratios set forth in the Order could result in regulators taking additional enforcement actions regarding the Bank. In addition, even if the Bank is successful in meeting the ~~difference~~capital ~~between~~ratios mandated in the Order, the Company may ~~interest~~need ~~earned~~to onraise ~~loans~~additional capital in the future. Additionally, because of the ~~securities~~Company’s ~~portfolios~~cumulative losses and ~~interest-earning~~its ~~deposits~~liquidity ~~offset~~and bycapital positions, the ~~cost~~FDIC ofand ~~funds,~~the ~~consisting~~Commissioner ~~principally~~may oftake additional significant regulatory action against the ~~interest~~Bank that ~~paid~~could, onamong ~~deposits~~other ~~and~~things, ~~borrowings~~materially adversely impact the Company’s stockholders. The Company’s ~~operations~~ability ~~are~~to ~~materially~~raise ~~affected~~additional bycapital ~~general economic~~is ~~conditions,~~contingent on the ~~monetary~~current ~~and~~capital ~~fiscal~~markets ~~policies~~and ofon the ~~Federal~~Company’s ~~government~~financial performance. Available capital markets are not currently favorable and management does not anticipate any material improvement in these markets in the ~~policies~~near term. Accordingly, management cannot be certain of ~~regulatory~~our ~~authorities~~ability to raise additional capital on any terms. If ~~Yields~~the Company cannot raise additional capital and/or ~~costs~~continue ~~have~~to ~~increased~~down-size ~~because~~operations ofand ~~the~~size ~~actions~~or ~~taken~~engage bya strategic merger or sale, the ~~Federal~~Company ~~Reserve~~may not be able to ~~increase~~sustain ~~interest~~further ~~rates~~deterioration ~~during~~in ~~2005~~ financial condition and other regulatory actions may be taken, including placing the ~~first~~Bank ~~six~~into ~~months~~receivership ofwith ~~2006~~the FDIC. InIf ~~addition~~the Bank is placed into receivership, ~~the~~it ~~cost~~is ofhighly ~~funds~~likely ~~has~~that ~~increased~~the ~~due~~Company inwould ~~part~~be required to ~~increased~~cease ~~competition~~operations ~~for~~and ~~deposits~~liquidate inor seek bankruptcy protection. If the ~~markets~~Company were into ~~which~~liquidate or seek bankruptcy protection, management does not believe that there would be assets available to holders of the ~~Bank~~capital ~~conducts~~stock ~~its~~of ~~business~~the Company.

~~Net~~Through ~~Income~~March 31, 2009, the Bank has sold $17,015 of loans classified as held for sale at December 31, 2008 at a slight gain and surrendered select bank-owned life insurance policies totaling $10,072. In addition, the Bank has experienced a reduction of loans held for investment of approximately $28,274 during the first quarter of 2009 primarily as a result of payoffs. As previously reported, the Company is undertaking certain actions designed to improve its capital position and has engaged financial advisors to assist with this effort and to evaluate the Company’s strategic options, including a possible sale or merger of the Company and/or possible sale of certain of the Bank’s assets. As of the filing of this Report, the Company believes that it needs to raise a minimum of $30.0 million of additional capital, assuming no change in risk-weighted assets or its capital position, in order to be capitalized at the levels required by the regulatory directives. To date, the Company has neither raised any additional capital nor agreed to a sale of the Company, the Bank, or any Bank assets (other

~~Net~~than ~~income~~Bank ~~for~~loans) ~~the~~and ~~three-month~~no ~~period~~assurances ~~ended~~can ~~March 31,~~be ~~2007~~made ~~increased~~as ~~$650,000~~ to ~~$2.1~~when ~~million, representing~~or awhether ~~44.7%~~such ~~increase~~capital ~~compared~~will tobe ~~the~~raised ~~same~~or ~~period~~whether ~~last year. The following analysis of~~ the Company’s ~~results of operations~~ will ~~explain~~be ~~the~~successful ~~significant~~in ~~changes~~negotiating a ~~that~~sale ~~had~~of anthe ~~effect~~Company onor ~~net~~any ~~income~~of ~~for~~its ~~the periods under review~~assets.

~~Interest~~The ~~Income~~accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future, and does not include any adjustments to reflect the possible future effects on the recoverability and classification of assets, or the amounts and classification of liabilities that may result from the outcome of any extraordinary regulatory action, which would affect the Company’s ability to continue as a going concern.

For the three-month period ended March 31, 2007, interest income increased 25.3% to $15.5 million compared to $12.3 million for the same period last year. The increase in interest income is primarily a result of the combined effect of the average balance of interest-earning assets increasing $94.5 million, or 13.0%, and the average yield increasing 75 basis points to 7.54% for the March 2007 quarter compared to 6.79% for the same period a year ago. The increase in average interest earning assets is primarily the result of a $97.2 million, or 14~~.6%,~~ increase in the average balance of loans compared to the three months ended March 31, 2006. As discussed earlier, loan growth during these periods is primarily a result of the growth of the markets in which the Bank conducts its business, the Bank’s expanded and improved branch network and the Bank’s continued emphasis on increasing overall loan production. The increase in the average yields is primarily due to the rising interest rate environment.

InterestTable Expenseof Contents

~~Interest expense increased $2.5 million, or 42.~~9~~%, to $8~~.3 ~~million~~Loans: ~~for~~Loans ~~the~~at ~~three-month period ended~~ March 31, ~~2007,~~2009 ~~compared to $5.8 million for the same period a year ago. This increase was caused by the combined effect of a 13.6% increase in the average balance of total interest-bearing liabilities~~ and ~~the~~December average cost of interest-bearing liabilities increasing to 4.44% from 3.53% compared to the same period a year ago. The increase in the average cost of funds was primarily due to the rising interest rate environment31, ~~increased~~2008 ~~competition~~are ~~for~~summarized ~~deposits,~~as and, to a lesser extent, the Bank’s offering of promotional rates on certificates of deposit and the Bank’s increased use of brokered deposits to fund loan growth. The increase in the average balance of interest-bearing liabilities is primarily the result of an $86.6 million, or 16.3%, increase in the average balance of deposits and, to a lesser extent, a $2.6 million, or 2.1% increase in the average balance of borrowed funds. The increase in the average balance of deposits is primarily attributable to the growth of the markets in which the Bank conducts its business, the Bank’s offering of promotional rates on certificates of deposit, the Bank’s expanded and improved branch network and the Bank’s use of brokered deposits. follows:

Net Interest Income


	March 31, 2009			December 31, 2008
Real estate:
Construction and land development	$	149,167		$	154,520
Mortgage:
One-to-four family residential		485,739			502,827
Multi-family residential		34,723			34,149
Commercial		121,669			124,726
Equity line		30,133			31,560
Other		715			805


Total real estate loans		822,146			848,587

Commercial, industrial, and agricultural		14,627			16,217
Consumer		7,739			8,279


Total gross loans		844,512			873,083

Unamortized net deferred fees		(1,590	)		(1,887	)


Total loans	$	842,922		$	871,196

~~Net~~The ~~interest~~Company’s ~~income~~recorded ~~for~~investment ~~the~~in ~~three~~one-~~month~~to-four ~~period~~family ~~ended~~residential, ~~March 31~~multi-family residential, ~~2007~~and ~~increased~~commercial ~~9.8%~~real toestate ~~$7.2~~loans ~~million~~presented ~~compared~~above toincludes ~~the~~loans ~~same~~for ~~period~~vacant aland ~~year~~in ~~ago.~~the ~~The~~amount ~~Average~~of ~~Yield/Cost Analysis~~$180,020, ~~table~~$18,837, ~~analyzes the interest-earning assets~~ and ~~interest-bearing~~$31,029, ~~liabilities~~respectively, ~~for~~at ~~the quarters ended~~ March 31, ~~2007~~2009, and ~~2006.~~$187,157, As$17,157, ~~stated~~and ~~earlier~~$31,123, ~~the~~respectively, ~~increase in average yield was primarily the result of increases in market interest~~at ~~rates. The interest rate spread was 3.09% for the quarter ended March~~December 31, ~~2007 compared to 3~~2008.~~26%~~ for the same period a year ago. The decrease in interest rate spread was primarily caused by the cost of interest-bearing liabilities going up 16 basis points more than the yield on interest-earning assets. This can be primarily attributed to the need of the Bank to generate liquidity in order to fund loan

15Activity in the allowance for loan losses during the quarters ended March 31, 2009 and 2008 is summarized as follows:

growth by paying higher rates of return on our deposit accounts in order to attract new deposits and retain existing deposit accounts. The net yield on interest-earning assets was 3.50% for the quarter ended March 31, 2007 compared to 3.60% for the same period a year earlier. See “Interest Income,” “Interest Expense” and “Average Yield/Cost Analysis” table for further information on interest income and interest expense.


	Three Months Ended March 31,
	2009			2008
Balance at beginning of year	$	36,262		$	8,788
Provision for loan losses		1,991			855
Loans charged-off		(8,739	)		(226	)
Recoveries		11			8


Balance at end of year	$	29,525		$	9,425

~~Average~~The ~~Yield/Cost~~following ~~Analysis~~is a summary of nonperforming loans at March 31, 2009 and December 31, 2008:

The following table contains information relating to the Company’s average balance sheet and reflects the average yield on interest-earning assets and average cost of interest-bearing liabilities for the periods indicated. Such annualized yields and costs are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. The average loan portfolio balances include nonaccrual loans.


	March 31, 2009		December 31, 2008
Loans past due ninety days or more and still accruing interest	$	12,197	$	4,276
Nonaccrual loans		71,666		76,213
Other troubled debt restructurings		140		—


Total	$	84,003	$	80,489

	For the quarter ended
(Dollars in thousands)	March 31, 2007					March 31, 2006
	AverageBalance		Interest		AverageYield/Cost	AverageBalance		Interest		AverageYield/Cost
ASSETS
Interest-earning assets:
Interest-bearing deposits in other banks	$	4,860	$	65	5.35%	$	8,052	$	100	4.97%
Securities:
Available for sale		42,878		490	4.57%		42,795		491	4.59%
Held to maturity		1,713		19	4.44%		2,001		22	4.40%
FHLB stock		6,454		94	5.83%		5,843		79	5.41%
All loans		765,090		14,798	7.74%		667,843		11,649	6.98%
Total interest-earning assets		820,995		15,466	7.54%		726,534		12,341	6.79%
Noninterest-earning assets		33,265					30,133
Total assets	$	854,260				$	756,667
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
Deposits	$	616,493		6,766	4.39%	$	529,901		4,431	3.34%
Borrowed funds		128,902		1,515	4.70%		126,272		1,365	4.32%
Total interest-bearing liabilities		745,395		8,281	4.44%		656,173		5,796	3.53%
Noninterest-bearing liabilities		49,705					50,556
Total liabilities		795,100					706,729
Stockholders' equity		59,160					49,938
Total liabilities and stockholders' equity	$	854,260				$	756,667
Net interest income			$	7,185				$	6,545
Interest rate spread					3.10%					3.26%
Net yield on interest-earning assets					3.50%					3.60%
Percentage of average interest-earning assets to average interest-bearing liabilities					110.1%					110.7%

16Table of Contents

~~Provision~~At March 31, 2009, $41,131 of the recorded investment in loans considered impaired in accordance with FAS No. 114 had a corresponding valuation allowance of $8,798. At December 31, 2008, $56,494 of the recorded investment in loans considered impaired in accordance with FAS No. 114 had a corresponding valuation allowance of $13,929. The recorded investment in impaired loans with no corresponding valuation allowance was $42,872 and ~~Reserve~~$23,995 ~~for~~at ~~Loan~~March 31, ~~Losses~~2009 and December 31, 2008, respectively.

~~During~~10. ~~the~~Regulatory ~~three-month~~Matters ~~period~~and ~~ended~~Capital ~~March 31,~~Requirements: ~~2007,~~Bankshares ~~the~~and ~~Bank had net charge-offs against~~ the ~~allowance for loan losses of $1,000 compared to $2,000 for the same period in 2006. The~~ Bank ~~added~~are ~~$300,000~~subject to ~~the allowance~~various ~~for~~regulatory ~~loan~~capital ~~losses~~requirements ~~for~~administered ~~the~~by ~~current~~federal ~~three-month~~and ~~period~~state ~~compared~~banking toagencies. ~~$585,000~~Failure ~~for the same period last year, increasing the balance~~ to ~~$8.1~~meet ~~million~~minimum atcapital ~~March 31,~~requirements ~~2007.~~can ~~The~~initiate ~~provision~~certain ~~was added due to overall growth of the loan portfolio~~mandatory, ~~the softening of the economy~~ and ~~the~~possibly ~~concentration~~additional ofdiscretionary ~~loans~~actions ~~secured~~ by ~~commercial~~regulators ~~real~~that, ~~estate.~~if ~~The~~undertaken, ~~decrease~~could inhave ~~the provision for loan losses for the March 2007 quarter compared to the March 2006 quarter was caused by~~ a ~~smaller~~direct ~~increase~~material ineffect ~~size~~on of the ~~loan~~ ~~portfolio during the first quarter of 2007 compared to the first quarter of 2006. The~~ Company’s ~~nonperforming~~consolidated ~~assets~~financial ~~(nonaccrual loans, loans 90 days or more delinquent and foreclosed real estate) were $1~~statements.8 ~~million,~~Quantitative ormeasures ~~0.21%~~established ofby ~~assets,~~regulation ~~at March 31, 2007, compared~~ to ~~$1.9~~ensure ~~million,~~capital oradequacy ~~0.23%~~require ofBankshares ~~assets, at December 31, 2006. The decrease in nonperforming assets during the first quarter of 2007 was the result of a decrease in delinquencies~~ and ~~foreclosed real estate owned. Management considers~~ the ~~current~~Bank ~~level of the allowance~~ to bemaintain ~~appropriate~~minimum ~~based~~amounts ~~on loan composition, the current level~~ and ~~types of delinquencies and other nonperforming assets~~ratios, ~~historical~~as ~~charge-off~~set ~~patterns,~~forth ~~overall economic conditions and other factors. Future increases to the allowance may be necessary due to changes~~ in loan composition or loan volume, changes in economic or market area conditions and other factors. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the ~~Company’s~~following ~~allowance for loan losses~~table. ~~Such agencies may require the recognition of adjustments to the allowance for loan losses based on their judgments of information available to them at the time of their examination.~~

~~Noninterest~~As ~~Income~~of March 31, 2009, the most recent notification from the FDIC categorized the Bank as “undercapitalized” pursuant to Part 325 of the FDIC Rules and Regulations. The Bank has been notified by the FDIC that, due to its capital ratios as of December 31, 2008, the Bank is now subject to restrictions on asset growth, dividends, other capital distributions, and management fees. In addition, the Bank may not accept, renew, or roll over any brokered deposit without obtaining a waiver from the FDIC, which approval has not been granted as of the filing of this Report. The Bank may also not solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the Bank’s normal market area or in the market area in which such deposits are being solicited.

~~Noninterest income~~To ~~increased~~be bycategorized ~~19.9%~~as towell ~~$1.3~~capitalized ~~million for~~ the ~~three-month~~Bank ~~period~~must ~~ended~~maintain ~~March 31,~~minimum ~~2007,~~amounts ~~compared~~and ~~to $1.1 million for the same period a year ago. In February 2007~~ratios, ~~there~~as ~~was~~set aforth ~~$275,000~~in ~~gain recognized on~~ the ~~sale~~table ~~of an unoccupied former branch office~~below. There ~~was~~are no ~~similar~~conditions ~~gain~~or events ~~recognized~~since ~~during~~that ~~the~~notification ~~quarter~~that ~~ended~~management ~~March 31,~~believes ~~2006.~~have ~~Deposit-related~~changed ~~fees increased $24,000 in~~ the ~~first~~Bank’s ~~quarter of 2007 compared to the same period a year ago~~category. The ~~change~~Bank’s inactual ~~deposit-related~~capital ~~fees~~amounts ~~was primarily due to increased income associated with non-sufficient funds~~ and ~~ATM~~ratios ~~fees~~are ~~due~~also topresented ~~increases~~ in ~~new~~the ~~deposit~~table ~~accounts.~~below ~~Gain~~as ~~on sale~~ of ~~loans and service charges and fees on loans decreased $47~~March 31,~~000~~ ~~and~~2009 ~~$30,000, respectively, primarily caused by a decrease in mortgage banking activities. Earnings on bank-owned life insurance~~ and ~~other income remained relatively constant during the period ended March~~December 31, ~~2007~~2008: ~~compared to a year earlier.~~

Noninterest Expense


							Minimum Ratio to Maintain
	March 31, 2009			December 31, 2008			Well-Capitalized Status	Adequately-Capitalized Status
Risk-based capital:
Tier I capital	$	35,469		$	34,285
Total capital		45,006			44,337
Risk-adjusted assets		742,942			777,966
Quarterly average tangible assets		967,750			985,704

Tier I capital ratio		4.77	%		4.41	%	6.00%	4.00%
Total capital ratio		6.06	%		5.70	%	10.00%	8.00%
Leverage capital ratio		3.67	%		3.48	%	5.00%	4.00%

~~For~~At ~~the three-month period ended~~ March 31, ~~2007~~ 2009, ~~noninterest~~the ~~expense~~Company’s ~~was~~total ~~$4.9~~Tier ~~million,~~I ~~an increase of $64~~capital,~~000,~~ ortotal ~~1.3%~~capital, ~~compared to the same period last year. Most of the increase in noninterest expense can be attributed to compensation~~ and ~~fringe~~leverage capital ~~benefits~~ratios ~~increasing~~were ~~$110,000 (~~3.760%~~) due to increases in costs of benefits~~, ~~increased staffing levels and normal increases in salaries~~5.98%, ~~Occupancy~~ and ~~equipment increased $18,000 (1~~2.976%), ~~professional~~respectively, ~~and~~as ~~exam~~compared ~~fees~~to ~~increased $9~~3.27%,~~000~~ (5.466%~~) and advertising increased $10~~,~~000 (7.5%) due~~ toand ~~normal increases~~2. ~~Other expenses decreased $83~~58%,~~000~~ ~~primarily due to decreases in printing and office supplies~~respectively, ~~telephone~~at ~~expense~~December 31, ~~postage and freight, franchise tax, and bank service charges~~2008.

~~Income~~11. ~~Taxes~~Recent Accounting Pronouncements: In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. However, in February 2008, the FASB issued FASB Staff Position 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for items within the scope of FSP 157-2. The Company adopted SFAS 157 on January 1, 2008, except as it applies to those non-financial assets and non-financial liabilities as

~~The~~16 effective tax rate for the three-month periods ended March 31, 2007 and 2006 was 36.3% and 34.5%, respectively. The Company began accruing at a higher tax rate in January 2007 in anticipation of an increased tax liability relating to increased tax rates on income in a higher bracket. For further information on income taxes, see “Income Taxes” in Management’s Discussion and Analysis and Note 10 of “Notes to Consolidated Financial Statements” included in the Annual Report.

ItemTable 3of Quantitative and Qualitative Disclosures About Market RiskContents

~~The Company’s~~noted ~~primary~~in ~~market~~FSP ~~risk is interest rate risk~~157-2. ~~Interest~~The ~~rate~~partial ~~risk~~adoption ~~is the result~~ of ~~differing~~SFAS ~~maturities~~157 ordid ~~repricing~~not ~~intervals~~have ofa ~~interest-earning~~significant ~~assets~~impact ~~and~~on ~~interest-bearing liabilities and~~ the ~~fact~~Company’s ~~that~~consolidated ~~rates on these~~ financial ~~instruments~~ ~~do not change uniformly~~statements. ~~These~~The ~~conditions~~adoption ~~may~~of ~~impact~~FSP ~~the earnings generated by the Company’s interest~~157-~~earning~~2 ~~assets~~on orJanuary ~~the~~1, ~~cost~~2009 ofdid ~~its~~not ~~interest-bearing~~have ~~liabilities,~~a ~~thus~~significant ~~directly~~impact ~~impacting~~on the Company’s ~~overall~~consolidated ~~earnings.~~financial ~~The Company’s management actively monitors and manages interest rate risk~~statements. ~~One way this is~~

17In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 amends and expands the disclosure requirement of Statement No. 133 for derivative instruments and hedging activities to provide users of financial statements with an enhanced understanding of the derivative instrument’s purpose, how it is accounted for, and its impact on the financial statements. This statement is effective for fiscal years beginning after November 15, 2008, with early adoption encouraged. The adoption of SFAS 161 on January 1, 2009 did not have a material effect on the Company’s consolidated financial statements.

~~accomplished~~In isApril ~~through~~2009, the ~~development~~FASB issued ofFASB Staff Position 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1 and ~~adherence~~APB 28-1”) to, ~~the~~require ~~Company’s~~disclosures ~~asset/liability~~about ~~policy.~~fair ~~This~~value ~~policy~~of ~~sets~~financial ~~forth~~instruments ~~management’s~~for ~~strategy~~interim reporting ~~for~~periods ~~matching~~as ~~the~~well ~~risk~~as ~~characteristics~~in ofannual ~~the~~financial ~~Company’s~~statements. ~~interest~~FSP 107-~~earning~~1 ~~assets~~ and ~~interest~~APB 28-~~bearing~~1 ~~liabilities~~also soamends asAPB toOpinion ~~mitigate~~No. 28, ~~the~~“Interim ~~effect~~Financial ofReporting”, ~~changes~~to require those disclosures in ~~the~~summarized ~~rate~~financial ~~environment~~information at interim reporting periods. FSP 107-1 and APB 28-1 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company’s ~~market~~is ~~risk~~in ~~profile~~the ~~has~~process ~~not~~of ~~changed~~reviewing ~~materially~~the potential impact of FSP ~~since~~107-1 ~~December 31~~and APB 28-1, ~~2006~~but the effect of adoption is not expected to have a material effect on the Company’s consolidated financial statements.

~~Item~~In 4April ~~Controls~~2009, the FASB issued FASB Staff Position 115-2 and ~~Procedures~~124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2 and 124-2”), which modifies and expands other-than-temporary impairment guidance for debt securities from Staff Accounting Bulletin Topic 5M, “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities”. FSP 115-2 and 124-2 addresses the unique features of debt securities and clarifies the interaction of the factors that should be considered when determining whether a debt security is other-than-temporarily impaired. FSP 115-2 and 124-2 expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. FSP 115-2 and 124-2 does not amend existing recognition and measurement guidance for other-than-temporary impairments. FSP 115-2 and 124-2 is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company is in the process of reviewing the potential impact of FSP 115-2 and 124-2, but the effect of adoption is not expected to have a material effect on the Company’s consolidated financial statements.

~~The~~From ~~Company’s~~time ~~management,~~to ~~including the Company’s principal executive officer and principal financial officer~~time, ~~has evaluated~~ the ~~effectiveness~~FASB ofissues ~~the~~exposure ~~Company’s~~drafts ~~“disclosure controls and procedures”, as such term is defined in Rule 13a-15(e) promulgated under the~~of ~~Securities~~proposed ~~Exchange~~statements ~~Act~~ of ~~1934,~~financial asaccounting ~~amended (the “Exchange Act”)~~standards. ~~Based~~Such ~~upon~~exposure ~~their~~drafts ~~evaluation,~~are ~~the~~subject ~~principal~~to ~~executive~~comment ~~officer~~from ~~and~~the ~~principal financial officer concluded that~~public, asto ofrevisions ~~the end of the period covered~~ by ~~this report,~~ the ~~Company’s~~ ~~disclosure~~FASB ~~controls~~ and ~~procedures were effective for the purpose of ensuring that the information required~~ to befinal ~~disclosed~~issuance inby the ~~reports~~FASB ~~that~~as ~~the~~statements ~~Company~~of ~~files~~financial oraccounting ~~submits~~standards. ~~under~~Management ~~the~~considers ~~Exchange Act with~~ the ~~Securities and Exchange~~ ~~Commission~~effect ~~(the~~of ~~“SEC”) (1) is recorded, processed, summarized and reported within~~ the ~~time~~proposed ~~periods~~statements ~~specified~~on in the ~~SEC’s~~consolidated ~~rules~~financial ~~and~~statements ~~forms,~~of ~~and (2) is accumulated and communicated to~~ the Company’s ~~management, including its principal executive~~ and ~~principal~~monitors ~~financial~~the ~~officers,~~status asof ~~appropriate~~changes to ~~allow timely decisions regarding required disclosure. In addition~~, ~~based~~and onproposed ~~that~~effective ~~evaluation,~~dates ~~no change in the Company’s internal control over financial reporting occurred during the quarter ended March 31~~of, ~~2007~~exposure ~~that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting~~drafts.

~~PART~~Item II2 ~~OTHER~~Management’s ~~INFORMATION~~Discussion and Analysis of Financial Condition and Results of Operations

~~Item~~Forward-Looking 1Statements ~~Legal Proceedings~~

~~Not~~This ~~applicable~~document, as well as other written communications made from time to time by Cooperative Bankshares, Inc. and subsidiaries and oral communications made from time to time by authorized officers of the Company, may contain statements relating to the future results of the Company (including certain projections, such as earnings projections, necessary tax provisions, and business trends) that are considered “forward looking statements” as defined in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). Such forward-looking statements may be identified by the use of such words as “intend,” “believe,” “expect,” “should,” “planned,” “estimated,” and “potential.” For these statements, the Company claims the protection of the safe harbor for forward-looking statements contained in the PSLRA. The Company’s ability to predict future results is inherently uncertain and the Company cautions you that a number of important factors could cause actual results to differ materially from those currently anticipated in any forward-looking statement.

~~Item~~17 ~~1a Risk Factors~~

InTable additionof to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Contents

~~Item~~These 2factors ~~Unregistered~~include ~~Sales~~but ofare ~~Equity~~not ~~Securities~~limited ~~and~~to: ~~Use of Proceeds~~

~~The Company~~• ~~did~~Recent ~~not~~and ~~purchase~~future ~~any~~bail-out ~~shares~~actions ofby ~~its common stock during~~ the ~~first quarter~~U.S. government;

~~Item~~• 3A ~~Defaults~~further ~~Upon~~slowdown ~~Senior~~in ~~Securities~~the national and North Carolina economies;

~~Not~~• ~~applicable~~A further deterioration in asset values locally and nationwide;

~~Item~~• 4The ~~Submission~~volatility of ~~Matters~~rate tosensitive ~~a Vote of Security Holders~~deposits;

~~None~~ • Changes in the regulatory environment;

~~Item~~• 5Governmental ~~Other~~action ~~Information~~as a result of our inability to comply with regulatory orders and agreements;

~~None~~• Increasing competitive pressure in the banking industry;

~~Item~~• 6Operational ~~Exhibits~~risks including data processing system failures or fraud;

Exhibit 3.1(1)		Articles of Incorporation
Exhibit 3.2(2)		Articles of Amendment to the Articles of Incorporation
Exhibit 3.3(3)		Bylaws, as amended
Exhibit 4.2		Registrant will furnish, upon request, copies of all instruments defining the rights of holders of long-term debt instruments of Registrant and its consolidated subsidiaries.
Exhibit 10.1(4)		Employment Agreement by and between Cooperative Bankshares, Inc., Cooperative Bank and Frederick Willetts, III, executed February 7, 2007
Exhibit 31.1		Rule 13a-14(a) Certification of Chief Executive Officer
Exhibit 31.2		Rule 13a-14(a) Certification of Chief Financial Officer
Exhibit 32		Certificate Pursuant to 18 U.S.C. Section 1350

•

Asset/liability matching risks and liquidity risks;

~~(1)~~• ~~Incorporated~~Continued byaccess ~~reference~~ to ~~the~~liquidity ~~Registrant’s Registration Statement on Form S-4 (Reg. No. 33- 79206) and any amendments thereto filed with the SEC.~~sources;

~~(2)~~• ~~Incorporated~~Changes byin ~~reference~~our ~~to the Registrant~~borrowers’s ~~Proxy~~performance ~~Statement filed with the SEC~~ on ~~March 30, 2005.~~loans;

~~(3)~~• ~~Incorporated~~Changes byin ~~reference~~critical toaccounting ~~the~~policies ~~Registrant’s~~and ~~Annual Report on Form 10-K filed with the SEC on March 15, 2007.~~judgments;

~~(4)~~• ~~Incorporated~~Changes byin ~~reference~~accounting topolicies ~~the~~or ~~Registrant’s~~procedures ~~Current~~as ~~Report~~may onbe ~~Form~~required ~~8-K~~by ~~filed~~the ~~with~~Financial ~~the~~Accounting ~~SEC~~Standards onBoard ~~February~~or ~~13,~~other ~~2007.~~regulatory agencies;

18• Changes in the equity and debt securities markets;

~~SIGNATURES~~• The effect of additional provision for loan losses;

~~Pursuant~~• toThe ~~the~~effect ~~requirements~~ of ~~the~~an ~~Securities~~impairment ~~Exchange~~charge ~~Act of 1934, the registrant has duly caused this report to be signed~~ on ~~its~~our ~~behalf~~deferred bytax ~~the undersigned thereunto duly authorized.~~ asset;

				Cooperative Bankshares, Inc.
Dated: May 9, 2007				/s/ Frederick Willetts, III
				Frederick Willetts, III
				President and Chief Executive Officer
				/s/ Todd L. Sammons
Dated: May 9, 2007				Todd L. Sammons
				Senior Vice President and Chief Financial Officer

•

Fluctuations of our stock price;

19• The success and timing of our business strategies;

•

The impact of reputation risk created by these developments on such matters as business generation and retention, funding and liquidity;

•

The impact of regulatory restrictions on our ability to receive dividends from our subsidiaries; and

•

Political developments, wars or other hostilities may disrupt or increase volatility in securities or otherwise affect economic conditions.

The consequences of these factors, any of which could hurt our business, could include, among others:

•

Because of the Company’s cumulative losses and its liquidity and capital positions, the FDIC and/or the Commissioner may take additional significant regulatory action against the Bank;

•

Our inability to continue to operate as a going concern;

•

Increased loan delinquencies;

•

An escalation in problem assets and foreclosures;

•

A decline in demand for our products and services;

•

A reduction in the value of the collateral for loans made by us, especially real estate, which, in turn would likely reduce our customers’ borrowing power and the value of assets and collateral associated with our existing loans;

•

A reduction in the value of certain assets held by us;

•

An inability to meet our liquidity needs;

•

An inability to raise capital to comply with the requirements of our regulators and for continued support of operations;

•

An inability to make or defer payments on our trust preferred securities; and

•

An inability to engage in certain lines of business.

Stockholders are cautioned not to place undue reliance on such statements, which speak only as of the date of those documents. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements above. Except to the extent required by applicable law or regulation, the Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

General

Cooperative Bankshares, Inc. (“Bankshares”) is a registered bank holding company incorporated in North Carolina in 1994. Bankshares is the parent company of Cooperative Bank (the “Bank”), a North Carolina chartered commercial bank headquartered in Wilmington, North Carolina. Cooperative Bank was chartered in 1898. As of March 31, 2009, the Bank provided financial services through twenty-two offices in North Carolina and three offices in South Carolina.

The Bank’s subsidiary, Lumina Mortgage Company, Inc. (“Lumina”), is a mortgage banking firm originating and selling residential mortgage loans through three offices in North Carolina. Lumina closed its Jacksonville office in April 2009. Bankshares, the Bank, and Lumina are collectively referred to herein as the “Company.”

Through its offices, the Bank provides a wide range of banking products, including interest-bearing and noninterest-bearing checking accounts, certificates of deposit, savings accounts, and individual retirement accounts. It offers an array of loan products such as overdraft protection, commercial, consumer, agricultural, real estate, residential mortgage, and home equity loans. Loan production has been significantly reduced due to limitations on asset growth and being categorized as “undercapitalized.” Restrictions on loan production due to limitations on asset growth as a result of our capital ratios is further explained in Capital Resources in “Management’s Discussion and Analysis” and Note 7 of “Notes to Consolidated Financial Statements” included in the Company’s Annual Report on Form 10-K filed with the SEC on May 1, 2009 (the “Annual Report”). Also offered are safe deposit boxes and automated banking services through Online Banking, Online Bill Pay, ATMs, and Access24 Phone Banking. In addition, the Bank’s third party partnership with Seagate Wealth Management Group through UVEST Investment Services gives customers access to a wide array of financial and wealth management solutions, including services relating to professional money management, retirement and education planning, and investment products (including stocks, bonds, mutual funds, annuities, and insurance products).

Mission Statement

It is the mission of the Company to provide the maximum in safety and security for our depositors, an equitable rate of return for our stockholders, and excellent service for our customers, and to do so while operating in a fiscally sound and conservative manner, with fair pricing of our products and services, good working conditions, outstanding training and opportunities for our staff, along with a high level of corporate citizenship.

Management Strategy

The Bank’s lending activities have traditionally concentrated on the origination of loans for the purpose of constructing, financing, or refinancing residential properties. However, during the last quarter of 2008, the Bank began to emphasize the origination of 1-4 family residential loans that could be sold in the secondary market. Unless otherwise stated, the Bank has generally halted or slowed the origination of loans held for investment beginning in the last quarter of 2008. Currently, the origination of new loans is typically limited to the refinancing of an existing loan held by the Bank or situations that improve the position of the Bank. As of March 31, 2009, $681.6 million, or 80.7%, of the Bank’s loan portfolio, which excludes loans held for sale, consisted of loans secured by residential properties as compared to $706.9 million, or 80.9%, at December 31, 2008. The Bank originates adjustable rate and fixed rate loans. As of March 31, 2009, adjustable rate and fixed rate loans totaled 66.4% and 33.6%, respectively, of the Bank’s total loan portfolio.

The Bank has chosen to sell a large percentage of its fixed rate mortgage loan originations in the secondary market and through brokered arrangements. This enables the Bank to invest these funds in other loans, while increasing fee income and reducing interest rate risk.

Interest Rate Sensitivity Analysis

Interest rate sensitivity refers to the change in interest spread resulting from changes in interest rates. To the extent that interest income and interest expense do not respond equally to changes in interest rates, or that all rates do not change uniformly, earnings will be affected. Interest rate sensitivity, at a point in time, can be examined using a static gap analysis that measures the match in balances subject to repricing between interest-earning assets and interest-bearing liabilities. Gap is considered positive when interest rate sensitive assets exceed interest rate sensitive liabilities. Gap is considered negative when interest rate sensitive liabilities exceed interest rate sensitive assets. At March 31, 2009, the Company had a one-year positive gap position of 17.9% compared to a positive gap position of 11.3% at December 31, 2008. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income, while a negative gap would tend to adversely affect net interest income. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income.

It is important to note that certain shortcomings are inherent in static gap analysis. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. For example, a part of the Company’s adjustable-rate mortgage loans have been indexed to the National Monthly Median Cost of Funds ratio for Office of Thrift Supervision regulated institutions. This index is considered a lagging index that may lag behind changes in market rates. The one-year or less interest-bearing liabilities also include checking, savings, and money market deposit accounts. Historically, the Company has experienced relatively modest repricing on these types of transaction accounts. Management takes this into consideration in determining acceptable levels of interest rate risk.

When Lumina enters into a rate lock commitment with a customer, there is a concurrent “lock in” for the loan with a secondary market investor under a best efforts delivery mechanism. Therefore, interest rate risk is mitigated because any commitment to fund a loan available for sale is concurrently hedged by a commitment from an investor to purchase the loan under the same terms. Loans originated by Lumina are usually sold within 30 days after closing.

Liquidity

The Company’s goal is to maintain adequate liquidity to meet potential funding needs of loan and deposit customers, pay operating expenses, and meet regulatory liquidity requirements. Maturing securities, principal repayments of loans and securities, proceeds from loan sales, growth in deposits, income from operations, and borrowings are the main sources of liquidity. The Bank has been granted a line of credit by the Federal Home Loan Bank of Atlanta (“FHLB”) and the Federal Reserve Bank of Richmond (the “Federal Reserve Bank”). At March 31, 2009, the Bank’s borrowed funds from the FHLB and the Federal Reserve Bank totaled $158.1 million, or 16.3% of its total assets. In February 2009, the Bank was notified by the FHLB that its FHLB line of credit had been reduced from $181.3 million to $168.1 million, the amount outstanding on the date of such notification. At March 31, 2009,

the Bank’s line of credit from the FHLB was $161.1 million. The Federal Reserve Board has also notified the Bank that it will permit the Bank to draw on its $21.6 million line of credit with the Federal Reserve Bank only in limited circumstances and for a short duration. Lumina borrows money on a short-term basis to fund its loans that are held for sale. At December 31, 2008, Lumina had $3.1 million of borrowed money from another financial institution. During the first quarter of 2009, the borrowing relationship utilized at December 31, 2008 was terminated and currently the Bank lends Lumina money to fund its loans that are held for sale. Scheduled loan repayments are a relatively predictable source of funds, unlike deposits and loan prepayments that are significantly influenced by general interest rates, economic conditions, and competition.

Previously, the Bank relied upon brokered deposits as a source of liquidity. As a result of the Bank’s capital ratios as of December 31, 2008, the Bank has been notified by the FDIC that it may not accept, renew, or rollover any brokered deposits without obtaining a waiver from the FDIC, as discussed in Note 7 of “Notes to Consolidated Financial Statements” included in the Company’s Annual Report. During the first quarter of 2009, the Bank continued offering promotional rates on other time deposits and increased internet deposits by $97.6 million to replace these maturities and improve liquidity.

At March 31, 2009, the estimated market value of liquid assets (cash, cash equivalents, marketable securities, and loans held for sale) was approximately $100.8 million, which represented 10.7% of deposits and borrowed funds, compared to $58.6 million, or 6.3% of deposits and borrowed funds, at December 31, 2008. The increase in liquid assets is a result of the Company’s effort to improve its liquidity position and was due to an increase in cash, partially offset by decreases in marketable securities and loans held for sale.

The Company’s primary uses of liquidity are to fund loans and to purchase investments. At March 31, 2009, management considered liquidity levels to be low, but sufficient, for purposes of meeting the Company’s cash flow requirements. The Company has undertaken action designed to increase liquidity through increased use of internet deposits, loan sales, or sales of other assets.

Off-Balance Sheet Arrangements and Contractual Commitments

At March 31, 2009, outstanding off-balance sheet commitments to extend credit totaled $62.7 million, and the undisbursed portion of construction loans was $38.5 million. The Company continued to be obligated to make future payments under contracts, such as debt and lease agreements, the amounts of which were consistent with the amounts at December 31, 2008, other than a decrease in borrowed funds of $56.1 million and an increase in deposits of $72.3 million at March 31, 2009. For further information on the Company’s off-balance sheet arrangements and contractual commitments, see the discussion regarding deposits and borrowed funds in Financial Condition at March 31, 2009 Compared to December 31, 2008.

Capital

Stockholders’ equity at March 31, 2009, was $20.5 million, an increase of 4.7% from $19.6 million at December 31, 2008. The change in capital position at March 31, 2009 reflects the impact of net income of $949,000. Stockholders’ equity at March 31, 2009 includes an unrealized gain net of tax of $316,000, compared to an unrealized gain net of tax of $356,000 at December 31, 2008, on securities available for sale marked to estimated fair market value.

Under the capital regulations of the Federal Deposit Insurance Corporation (“FDIC”), the Bank must satisfy minimum leverage ratio requirements and risk-based capital requirements. Banks supervised by the FDIC must maintain a minimum leverage ratio of core (“Tier I”) capital to average adjusted assets of at least 3% if the most highly rated and at least 4% for others. At March 31, 2009, the Bank’s leverage capital ratio was 3.67%. The FDIC’s risk-based capital rules require banks supervised by the FDIC to maintain risk-based capital to risk-weighted assets of at least 8.00%. Risk-based capital for the Bank is generally defined as Tier I capital plus the balance of the allowance for loan losses. At March 31, 2009, the Bank had a ratio of qualifying total capital to risk-weighted assets of 6.06%.

As of March 31, 2009, the most recent notification from the FDIC categorized the Bank as “undercapitalized” pursuant to Part 325 of the FDIC Rules and Regulations. The Bank has been notified by the FDIC that, due to its capital ratios as of December 31, 2008, the Bank is now subject to restrictions on asset growth, dividends, other

capital distributions, and management fees. In addition, the Bank may not accept, renew, or roll over any brokered deposit without a waiver from the FDIC which, as of the date of this report, has not been received. The Bank may also not solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the Bank’s normal market area or in the market area in which such deposits are being solicited. As a result of capital levels and findings from the FDIC’s Report of Examination as of November 10, 2008, the Bank entered into the Consent Agreement effective March 12, 2009 with the FDIC and the North Carolina Commissioner of Banks (“the Commissioner”), whereby the Bank consented to the issuance of an Order to Cease and Desist promulgated by the FDIC and the Commissioner. For additional information regarding the Consent Agreement and the Order, see the Current Report on Form 8-K filed with the SEC on March 18, 2009.

The Company, as a bank holding company, is also subject, on a consolidated basis, to the capital adequacy guidelines of the Board of Governors of the Federal Reserve (the “FRB”). The capital requirements of the FRB are similar to those of the FDIC governing the Bank. In February 2009, the Company was notified by the FRB that the overall condition of the Company and the Bank is less than satisfactory. As a result, prior to the payment of any capital distribution, such as stockholder dividends, or the payment of any debt service, including payments related to any outstanding trust preferred securities, the Company must obtain prior written approval from the FRB. Additionally, the Company will be required to comply with (i) the provisions of Section 32 of the Federal Deposit Insurance Act and Section 225.71 of the Rules and Regulations of the Board of Governors of the Federal Reserve System with respect to the appointment of any new Company directors or the hiring or change in position of any Company senior executive officer and (ii) the restrictions on making “golden parachute” payments set forth in Section 18(k) of the Federal Deposit Insurance Act.

Critical Accounting Policies

The Company’s most significant critical accounting policies are those that govern accounting for the allowance for loan losses, the valuation allowance on net deferred tax assets, and fair value estimates. A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results of operations and requires a difficult, subjective, and/or complex judgment by management. What makes these judgments difficult, subjective, and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. For further information on the Company’s critical accounting policies, see Critical Accounting Policies in “Management’s Discussion and Analysis” and Note 1, Note 10, and Note 12 of “Notes to Consolidated Financial Statements” included in the Company’s Annual Report.

FINANCIAL CONDITION AT MARCH 31, 2009 COMPARED TO DECEMBER 31, 2008

The Company’s total assets increased 1.7% to $967.3 million at March 31, 2009, compared to $951.0 million at December 31, 2008. Asset growth was primarily attributable to an increase of $55.8 million in cash and cash equivalents, a result of the Company’s effort to improve its liquidity position. The increase in cash was funded by a decrease in loans as well as an increase in deposits, partially offset by a reduction in borrowings. Loans decreased 3.2% to $842.9 million. In an effort to improve liquidity and capital positions and comply with regulatory directives, the Company has halted or slowed the origination of loans beginning in the fourth quarter of 2008. This decrease in new loan originations compounded with loan payoffs during the first quarter of 2009 are the primary reasons for the decrease in loans for the period. The bulk of the decrease in the loan portfolio during the quarter ended March 31, 2009 occurred in one-to-four family loans, which decreased $17.1 million, or 3.4%, and construction and land development loans, which decreased $5.4 million, or 3.5%, as compared to the amounts at December 31, 2008. Investment securities held to maturity decreased $2.1 million from $3.3 million to $1.2 million. This decrease is primarily attributable to an investment that matured during the first quarter of 2009.

At March 31, 2009, the Bank’s allowance for loan losses was $29.5 million, or 3.50% of loans, compared to $36.3 million, or 4.16% of loans, at December 31, 2008. The Company’s nonperforming assets, which consist of accruing loans ninety days or more delinquent, nonaccrual loans, other troubled-debt restructurings, and foreclosed real estate owned, were $99.2 million, or 10.26% of assets, at March 31, 2009, compared to $91.6 million, or 9.63% of assets, at December 31, 2008. Accruing loans ninety days or more delinquent increased to $12.2 million at March 31, 2009 from $4.3 million at December 31, 2008. Foreclosed real estate increased to $15.2 million at March 31, 2009 from $11.1 million at December 31, 2008. Also, at March 31, 2009, foreclosed real estate owned consisted of fifty-four properties with an average value of $281,000 compared to forty-three properties with an average value of $258,000

at December 31, 2008. Other troubled-debt restructurings, which consist of those troubled-debt restructurings still accruing, increased to $140,000, at March 31, 2009 from $0 at December 31, 2008. Nonaccrual loans decreased to $71.7 million at March 31, 2009 from $76.2 million at December 31, 2008. The decrease in the ratio of allowance for loan losses to loans from December 31, 2008 to March 31, 2009 was primarily due to a decrease in valuation allowances for the recorded investment in nonperforming loans, mostly as a result of charging off valuation allowances established at December 31, 2008 as some of the collectibility of corresponding nonperforming loans has been doubtful. The valuation allowance on impaired loans totaled $8.8 million at March 31, 2009 compared to $13.9 million at December 31, 2008. For additional information regarding the allowance for loan losses and the Bank’s valuation allowances for nonperforming loans, see Comparison of Operating Results – Provision and Allowance for Loan Losses.

Management believes that the current level of the allowance is appropriate based on collectibility of the loans, loan composition, the current level and types of delinquencies and other nonperforming assets, historical charge-off patterns, overall economic conditions, and other factors. Future increases to the allowance may be necessary due to changes in loan composition or loan volume, changes in economic or market area conditions, and other factors. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the recognition of adjustments to the allowance for loan losses based on their judgments of information available to them at the time of their examination.

Other assets increased $718,000, or 9.3%, to $8.5 million primarily due to an increase in prepaid expenses, returned items, and mortgage servicing rights. Loans held for sale decreased $11.4 million, or 67.2%, since December 31, 2008 to $5.6 million at March 31, 2009. The decrease in loans held for sale during the first quarter of 2009 is the result of transferring $13.9 million of loans held for investment to loans held for sale at December 31, 2008 and the sale of all loans held for sale as of December 31, 2008 during the first quarter of 2009. No such similar transfer of loans held for investment to loans held for sale occurred during the quarter ended March 31, 2009. Bank-owned life insurance decreased $10.0 million to $1.6 million as a result of the Company’s decision, in agreement with directors and applicable executive officers, to increase liquidity by surrendering select bank-owned life insurance policies during the quarter ended March 31, 2009. Concurrent with the decision to surrender select bank-owned life insurance policies, the Company reversed its related EITF 06-4 accrual, resulting in an adjustment of $1.1 million, and accounting for the majority of the $908,000 decrease of accrued expenses and other liabilities. Investment securities available for sale, accrued interest receivable, premises and equipment, and intangible assets remained relatively unchanged during the three months ended March 31, 2009.

Borrowed funds at March 31, 2009 decreased $56.1 million to $173.5 million since December 31, 2008, offset by an increase of $72.3 million of deposits resulting from promotional rates offered during the period on time deposits and internet deposits. The shift in funding sources from December 31, 2008 to March 31, 2009 is partially related to notifications received from the FHLB and Federal Reserve Board regarding the Bank’s lines of credit with each institution as discussed earlier within Liquidity. Advances from the FHLB are collateralized by the Bank’s investment in FHLB stock and qualifying first mortgage loans, lines of credit, and commercial loans. Borrowings from the FRB are collateralized by qualifying construction, land development, and other land loans. The Bank’s investment in FHLB stock increased $1.0 million to $9.3 million at March 31, 2009 because stock ownership requirements with the FHLB are tied to the Bank’s borrowings from the FHLB. Escrow deposits and accrued interest payable remained relatively unchanged during the three months ended March 31, 2009.

COMPARISON OF OPERATING RESULTS

Overview

The net income of the Company depends primarily upon net interest income. Net interest income is the difference between the interest earned on loans, the securities portfolio, and interest-earning deposits offset by the cost of funds, consisting principally of the interest paid on deposits and borrowings. The Company’s operations are materially affected by general economic conditions, the monetary and fiscal policies of the Federal government, and the policies of applicable regulatory authorities. Yields and costs have decreased primarily because of actions taken by the Federal Reserve to reduce interest rates by 400 basis points during 2008.

Net Income

The Company reported net income of $949,000 for the quarter ended March 31, 2009 compared to net income of $752,000 for the quarter ended March 31, 2008. The following analysis of the Company’s results of operations will explain the significant changes that had an effect on net income for the periods under review.

Interest Income

For the three-month period ended March 31, 2009, interest income decreased 20.4% to $12.2 million compared to $15.3 million for the prior year period. The decrease in interest income is primarily a result of the average yield decreasing 175 basis points to 5.12% for the quarter ended March 31, 2009 compared to 6.87% for the same period a year ago, partially offset by an increase in the average balance of interest-earning assets of $60.2 million to $950.6 million. In addition to the impact of rate cuts described earlier, the rise in nonaccrual loans has resulted in an increase of unrecognized accrued interest, which accounted for a 29 basis point decrease of the average yield of loans during the quarter ended March 31, 2009 compared to the prior year period. The increase in average interest earning assets is primarily the result of an increase of $45.7 million, or 5.5%, in the average balance of loans and an increase of $27.2 million, or 711.6%, in the average balance of interest-bearing deposits compared to the three months ended March 31, 2008. The increases in the average balance of loans and interest-bearing deposits during the quarter ended March 31, 2009 was partially offset by a reduction of $13.3 million, or 30.9%, in the average balance of available for sale securities compared to the three months ended March 31, 2008. For a discussion regarding loan and interest-bearing deposit growth, see Financial Condition at March 31, 2009 Compared to December 31, 2008.

Interest Expense

Interest expense decreased $1.6 million, or 18.3%, to $7.4 million for the three-month period ended March 31, 2009, compared to $9.0 million for the same period a year ago. This decrease was caused by a reduction of 113 basis points on the average cost of interest-bearing liabilities to 3.26% at March 31, 2009 from 4.39% at March 31, 2008, partially offset by a 10.1% increase in the average balance of total interest-bearing liabilities during these same periods. The increase in interest-bearing liabilities is the result of a $52.5 million increase, or 37.2%, in the average balance of borrowed funds, and an increase of $30.3 million, or 4.5%, in the average balance of deposits for the three months ended March 31, 2009 compared to the same period a year earlier. For a discussion regarding deposit and borrowings growth, see Financial Condition at March 31, 2009 Compared to December 31, 2008.

Net Interest Income

Net interest income for the three-month period ended March 31, 2009 decreased 23.4% to $4.8 million compared to the same periods a year ago. The Average Yield/Cost Analysis table analyzes the interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2009 compared to the same period a year ago. As stated earlier, the decreases in the average yield were primarily the result of action taken by the Federal Reserve. The interest rate spread for the three-month period ended March 31, 2009 was 1.86% compared to 2.48% for the same period a year ago. The decrease in interest rate spread for the three-month period was primarily caused by a decrease to the average yield on interest-earning assets of 175 basis points, with a smaller decline of 113 basis points in the average cost of interest-bearing liabilities. The yield on interest-earning assets has decreased faster than the cost of interest-bearing liabilities for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 because the Bank’s loan portfolio has repriced faster than deposits as a result of the rate cuts implemented by the Federal Reserve. In addition, deposit rates have not fallen as far as the loan rates and the rise in nonaccrual loans has adversely affected the interest rate spread during the quarter ended March 31, 2009. See Overview, Interest Income, Interest Expense, and Average Yield/Cost Analysis for further information on interest income and interest expense.

Average Yield/Cost Analysis

Average Yield / Cost Analysis


	For the Quarter Ended
(Dollars in thousands)	March 31, 2009						March 31, 2008
	Average Balance		Interest		Average Yield/ Cost		Average Balance		Interest		Average Yield/ Cost
ASSETS
Interest-earning assets:
Interest-bearing deposits in other banks	$	31,053	$	13	0.17	%	$	3,826	$	34	3.55	%
Securities:
Available for sale		29,723		317	4.27	%		43,014		552	5.13	%
Held to maturity		3,143		40	5.09	%		4,490		57	5.08	%
FHLB stock		9,010		—	0.00	%		7,114		106	5.96	%
All loans		877,687		11,809	5.38	%		831,988		14,547	6.99	%

Total interest-earning assets		950,616		12,179	5.12	%		890,432		15,296	6.87	%

Noninterest-earning assets		17,864						44,525

Total assets	$	968,480					$	934,957


LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Deposits	$	709,133		5,632	3.18	%	$	678,823		7,355	4.33	%
Borrowed funds		193,726		1,726	3.56	%		141,236		1,650	4.67	%

Total interest-bearing liabilities		902,859		7,358	3.26	%		820,059		9,005	4.39	%

Noninterest-bearing liabilities		44,535						49,308

Total liabilities		947,394						869,367
Stockholders’ equity		21,086						65,590

Total liabilities and stockholders’ equity	$	968,480					$	934,957

Net interest income			$	4,821					$	6,291

Interest rate spread					1.86	%					2.48	%

Net yield on interest-earning assets					2.03	%					2.83	%

Percentage of average interest-earning assets to average interest-bearing liabilities					105.3	%					108.6	%

Provision and Allowance for Loan Losses

During the three-month period ended March 31, 2009, the Bank had net charge-offs against the allowance for loan losses of $8.7 million compared to $218,000 for the same period in 2008. This increase was primarily the result of charging off various nonperforming loans that had a valuation allowance established at December 31, 2008 and the collectibility of the loans becoming doubtful. The Bank added $2.0 million to the allowance for loan losses through the provision for loan losses for the three-month period ended March 31, 2009 compared to $855,000 for the same period last year. The increase in the provision was primarily the result of adjustments to valuation allowances for the recorded investment in nonperforming loans. At March 31, 2009, the recorded investment in nonperforming loans (nonaccrual loans, accruing loans ninety days or more delinquent, and other troubled debt restructurings) was $84.0 million with corresponding valuation allowances of $8.8 million. The provision for loan losses was also affected by a decrease in the valuation allowance allocated to the remainder of the loan portfolio, primarily due to a decrease in loans during the first quarter of 2009. For information regarding the change in nonperforming loans during the first three months of 2009, see Financial Condition at March 31, 2009 Compared to December 31, 2008.

Noninterest Income

Noninterest income increased to $1.6 million for the three-month period ended March 31, 2009 compared to $1.3 million for the same period a year ago. Gain on sale of loans increased $456,000 primarily due to an increase of income recognized on loans sold to investors as a result of an increase in the volume of loans sold to increase liquidity and improve capital ratios. Service charges and fees on loans decreased $60,000 mostly because the Company originated less broker loans in the three months ended March 31, 2009 compared to the same period a year earlier. Earnings on bank-owned life insurance decreased to $63,000 for the quarter ended March 31, 2009 compared to $89,000 for the quarter ended March 31, 2008 primarily a result of the Company’s decision to surrender select bank-owned life insurance policies during the first quarter of 2009 as discussed in Financial Condition at March 31, 2009 compared to December 31, 2008. Deposit-related fees and other income remained relatively constant during the three months ended March 31, 2009 compared to the same period a year earlier.

Noninterest Expense

For the three-month period ended March 31, 2009, noninterest expense decreased 9.1% to $5.1 million compared to $5.6 million for the same period last year. The majority of this change during the first quarter of 2009 compared to the same period last year is related to a decrease of $1.6 million of compensation and fringe benefits. Most of the decrease of compensation and fringe benefits relates to the $1.1 million reversal of the EITF 06-4 accrual related to the Company’s decision to surrender select bank-owned life insurance policies as discussed in Financial Condition at March 31, 2009 Compared to December 31, 2008. The remainder of the decrease in compensation and fringe benefits is related to salary and benefit reductions implemented in the fourth quarter of 2008 or in the first quarter of 2009. The Company recorded a net gain on other real estate owned of $52,000 for the quarter ended March 31, 2009, primarily a result of positive adjustments to fair value of several properties foreclosed on during the first quarter of 2009, compared to a net loss of $215,000 for the same period a year earlier, which was a result of several write-downs to fair value on foreclosed real estate. Advertising expense decreased $73,000 during the first quarter of 2009 compared to the same period a year earlier as a result of the Bank’s effort to reduce advertising expense in 2009. Professional and consulting fees for the quarter ended March 31, 2009 compared to the quarter ended March 31, 2008 increased $775,000, primarily a result of additional legal, accounting, consulting, and financial advisory fees related to the preparation of the Company’s Annual Report on Form 10-K and the Company’s efforts to raise capital, sell assets, and comply with regulatory directives. FDIC premiums for the quarter ended March 31, 2009 compared to the quarter ended March 31, 2008 increased $676,000, primarily a result of the Company’s undercapitalized status and additional assessments related to the FDIC’s Restoration Plan discussed in Note 17 of “Notes to Consolidated Financial Statements” included in the 2008 Annual Report. Occupancy and equipment costs

and other expenses remained relatively unchanged during the three-month period ended March 31, 2009 compared to the three-month period ended March 31, 2008.

Income Taxes

The effective tax rate for the three-month periods ended March 31, 2009 and 2008 was 247.8% and 32.3%, respectively. The change in effective tax rates for the three-month period ended March 31, 2009 was primarily related to a recoverable current tax benefit of $1.0 million, mostly a result of a decrease to the allowance for loan losses during the first quarter of 2009 due to net charge offs exceeding the provision for loan losses. For further information on charge offs and the provision for loan losses, see Provision and Allowance for Loan Losses. The Company’s 2005, 2006, and 2007 federal and state tax returns are subject to examination by federal and state tax authorities. For further information on income taxes, see Income Taxes in “Management’s Discussion and Analysis” and Note 10 of “Notes to Consolidated Financial Statements” included in the 2008 Annual Report.

Item 3

Quantitative and Qualitative Disclosures About Market Risk

The Company’s primary market risk is interest rate risk. Interest rate risk is the result of differing maturities or repricing intervals of interest-earning assets and interest-bearing liabilities and the fact that rates on these financial instruments do not change uniformly. These conditions may impact the earnings generated by the Company’s interest-earning assets or the cost of its interest-bearing liabilities, thus directly impacting the Company’s overall earnings. The Company’s management actively monitors and manages interest rate risk. One way this is accomplished is through the development of, and adherence to, the Company’s asset/liability policy. This policy sets forth management’s strategy for matching the risk characteristics of the Company’s interest-earning assets and interest-bearing liabilities so as to mitigate the effect of changes in the rate environment.

One way to measure the Company’s potential exposure to interest rate risk is to estimate the effect of a change in rates on the Company’s economic value of equity (“EVE”). EVE is the net present value of the Company’s portfolio of assets and liabilities. By marking-to-market the components of the balance sheet, management can compute the EVE. As rates change over time, the market values of the Company’s assets and liabilities will change, with longer-term products fluctuating more than short-term products. In most cases, rate-sensitive assets and liabilities will not have the same maturity characteristics. Therefore, as rates vary, the market value of the rate-sensitive assets will not change equally with the market value of rate-sensitive liabilities. This will cause the EVE to vary. The focus of the EVE is to determine the percentage decline in the net economic value of equity caused by a 1% or 2% increase or decrease in interest rates, whichever produces the larger decline. A large value indicates a large percentage decline in the EVE due to changes in interest rates and, thus, higher interest rate sensitivity. A low value indicates a small percentage decline in the EVE due to changes in interest rates and, thus, lower interest rate sensitivity. The results are compared to limits set by the Board of Directors and are monitored to identify unfavorable trends. In a rising rate environment, EVE would be positively affected at March 31, 2009 and December 31, 2008. The percentage change in EVE in a rising rate environment is more pronounced at March 31, 2009 compared to December 31, 2008. This indicates that, as of March 31, 2009, the Company has greater interest rate sensitivity in a rising rate environment as compared to December 31, 2008. It should be noted, however, that at March 31, 2009 and December 31, 2008, the intended federal funds rate set by the Federal Reserve was 0.25%. For this reason, a 100 or 200 basis point decline in interest rates is not an available option for the Federal Reserve. As a result, the EVE under these scenarios at March 31, 2009 and December 31, 2008 has been identified as not applicable (“N/A”).

The following table sets forth information relating to the Company’s economic value of equity and the estimated changes under various interest rate change scenarios over a one year time horizon as of March 31, 2009 and December 31, 2008. Computation of prospective effects of hypothetical interest rate changes, such as the following computations, are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Furthermore, the computations do not contemplate any actions management could undertake in response to sudden changes in interest rates. For additional information regarding market risk, see our Annual Report on Form 10-K for the year ended December 31, 2008.


Market Risk Table
(Dollars in thousands)	March 31, 2009
Change in Interest Rates	Economic Value of Equity		Estimated $ Change		Estimated % Change
200 basis point rise	$	26,886	$	10,766	67	%
100 basis point rise		22,697		6,577	41	%
Base Scenario		16,120		—	—
100 basis point decline		N/A		N/A	N/A
200 basis point decline		N/A		N/A	N/A

	December 31, 2008
Change in Interest Rates	Economic Value of Equity		Estimated $ Change		Estimated % Change
200 basis point rise	$	31,153	$	6,565	27	%
100 basis point rise		30,927		6,339	26	%
Base Scenario		24,588		—	—
100 basis point decline		N/A		N/A	N/A
200 basis point decline		N/A		N/A	N/A

Item 4 (T)

Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) and 15(d)-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were not effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

In connection with the above evaluation of our disclosure controls and procedures, no change in our internal control over financial reporting was identified that occurred during the quarter ended March 31, 2009 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. The Company is taking steps to remediate the material weaknesses, including designing and implementing additional control procedures, and implementing additional review processes over these controls. Except for these ongoing remediation efforts, there were no changes in our internal control over financial reporting that occurred subsequent

to the period covered by management’s report on internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II OTHER INFORMATION

Item 1

Legal Proceedings

Not applicable

Item 1A

Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2008, which could materially affect our business, financial condition, or future results. The risks described in our Annual Report on Form 10-K are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results.

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

The Company did not purchase any shares of its common stock during the three months ended March 31, 2009.

Item 3

Defaults Upon Senior Securities

Not applicable

Item 4.

Submission of Matters to a Vote of Security Holders

None

Item 5

Other Information

None

Item 6

Exhibits


Exhibit 3.1		Articles of Incorporation (1)

Exhibit 3.2		Articles of Amendment to the Articles of Incorporation (2)

Exhibit 3.3		Amended and Restated Bylaws (3)

Exhibit 4.2		Registrant will furnish, upon request, copies of all instruments defining the rights of holders of long-term debt instruments of Registrant and its consolidated subsidiary.

Exhibit 10.1		Stipulation and Consent to the Issuance of an Order to Cease and Desist (4)

Exhibit 10.2		Order to Cease and Desist issued by the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks (4)

Exhibit 10.3		Written Agreement by and between Cooperative Bankshares, Inc. and the Federal Reserve Bank of Richmond (5)

Exhibit 31		Rule 13a-14(a) Certification of Chief Executive Officer and Chief Financial Officer

Exhibit 32		Certification pursuant to 18 U.S.C. Section 1350

(1)

Incorporated by reference to the Registrant’s Registration Statement on Form S-4 (Reg. No. 33- 79206) and any amendments thereto filed with the SEC.

(2)

Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on May 9, 2008.

(3)

Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the SEC on April 29, 2008.

(4)

Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the SEC on March 18, 2009.

(5)

Incorporated by reference to the Registrant’s Current Report on Form 8-K filed with the SEC on May 1, 2009.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		Cooperative Bankshares, Inc.

		/s/ Todd L. Sammons
Dated: May 19, 2009		Todd L. Sammons
		Chief Financial Officer and Interim
		President and Chief Executive Officer

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